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info@reason.org (Reason Foundation)http://www.pjdoland.com/chai/?v=0.1Pension Reform Will Help Michigan Teachershttp://www.reason.org/news/show/pension-reform-will-help-michigan-t
The Detroit News <p>Teaching in Michigan is about to become a lot more attractive. Recently enacted legislation will improve retirement choices for future teachers, increase compensation for some recently hired teachers, and ensure the state will pay every dollar of pensions promised to teachers.</p>
<p>Costs of paying off the state&rsquo;s rising teacher pension debt are scheduled to skyrocket and consume any future resources that could otherwise be used to increase teacher pay or get money into the classrooms. Absent reform, this debt growth would have been unconstrained and posed a threat to the retirement of teachers across the state.</p>
<p>Retirement security and good compensation for teachers are important issues to us. Professionally, we work on a national project that aims to ensure pension plan solvency and retirement security for public sector workers. Personally, we both have close family who are active or retired teachers in Michigan.</p>
<p>We firmly believe that states need to keep 100 percent of their pension promises, and Michigan&rsquo;s new reform legislation does that. First, all new teachers will have a real choice of retirement plans upon hiring and can pick the option that works best for them and their families. The default is a &ldquo;defined contribution&rdquo; retirement plan similar to the 401(k)s offered in the private sector, but with a big difference &mdash; teachers do not have to pick their own investments or make strategic allocation of assets if they do not want to.</p>
<p>Teachers could simply set their preferred retirement date &mdash; say 35 years in the future &mdash; and let professionally designed &ldquo;target date funds&rdquo; reallocate their assets over time in a way that creates minimal risk and maximizes return. And they can choose to purchase annuities if they&rsquo;d like their benefits distributed just like a traditional pension check.</p>
<p>The other option is a &ldquo;Pension Plus&rdquo; plan with the same defined benefit pension currently offered to teachers, but with its own big difference &mdash; the state will be more honestly accounting for the cost of providing this new benefit than they are now. Ensuring that pension benefits are accurately priced by actuaries to avoid pension debt is what makes Michigan&rsquo;s new retirement legislation so strong. Plus, where teachers currently pay two-thirds of the costs of the pension plan, under the new design they will pay 50 percent of costs.</p>
<p>Second, 20 percent of teachers hired since 2012 have chosen an optional&mdash;but weak&mdash;401(k)-style benefit over a pension, where if they put in 6 percent, their employer matches an additional (and skimpy) 3 percent. The reform upgrades this benefit to match the new defined contribution plan, where new teachers will only have to put in 3 percent of their salary and to get 7 percent from their employer.</p>
<p>Last, for retirees or teachers who have already earned pensions, the adopted legislation creates a viable path to solvency for their beleaguered pension fund $29 billion in debt. Absent changes, Michigan was on track to see pension debt payments effectively double by the 2030s, requiring billions in annual debt payments for teacher pensions coming out of the state&rsquo;s School Aid fund (instead of going into the classroom or enabling teacher pay increases).</p>
<p>Unfortunately, the state has currently saved less than 60percent of the money it needs to pay promised pension benefits. This dismal fiscal position is mostly because actuarial assumptions used to determine annual contributions for the pension fund have been consistently inaccurate. For example, the state has consistently underperformed its expected rate of return on invested assets for the past 20 years. As a result, Michigan had over $2 billion in required pension debt payments last year &mdash; more than 25 percent of the amount paid in salary to teachers.</p>
<p>Fortunately, the Legislature and governor are embracing more realistic assumptions about the cost of funding pensions and planning to chip in more money every year down the road to get pension debt paid off. While there is still more room to adopt better assumptions, this year&rsquo;s state budget allocates an additional down payment towards the debt of over $200 million.</p>
<p>Teachers themselves should welcome the new reforms. Not a single dollar of pension benefits was cut. Teachers currently in a weak retirement plan are getting a sweetened benefit in the process. Future teachers will have a real choice between generous defined contribution plan or a pension (with a similar benefit as today&rsquo;s teachers). And the Legislature is depositing hundreds of millions more into the pension fund. All together, the reform package will ensure retirement security for every teacher in Michigan.</p>
<p><em><a href="http://www.detroitnews.com/story/opinion/2017/07/06/column-pension-reform-will-help-mich-teachers/103459094/">This column originally appeared in The Detroit News</a>.</em></p>1014974@http://www.reason.orgThu, 06 Jul 2017 00:03:00 EDTanthony.randazzo@reason.org (Anthony Randazzo)Pension Reform Newsletter - June 2017http://www.reason.org/news/show/pension-reform-newsletter-jun17
<p>This newsletter from the Pension Integrity Project at Reason Foundation highlights articles, research, opinion, and other information related to public pension challenges and reform efforts across the nation. You can find previous editions <a href="http://reason.org/newsletters/pensionreform/">here</a>.</p>
<p><strong><span style="font-size: 120%;">In This Issue:</span></strong></p>
<p><strong><a href="#a">Articles, Research &amp; Spotlights</a></strong></p>
<ul type="disc">
<li><a href="#b">Michigan Adopts Nation's Most Innovative Teacher Pension Reform</a></li>
<li><a href="#c">Pennsylvania Enacts Major Pension Reform</a></li>
<li><a href="#d">Texas Enacts Dallas, Houston Pension Reform Legislation</a></li>
<li><a href="#e">Florida to Default New Hires to Defined Contribution Retirement Plan</a></li>
</ul>
<p><strong><a href="#i">News Notes</a></strong></p>
<p><strong><a href="#j">Quotable Quotes on Pension Reform</a></strong></p>
<p><strong><a href="#k">Contact the Pension Reform Help Desk</a></strong></p>
<hr />
<p><a name="a"></a><strong><span style="font-size: 120%;">Articles, Research &amp; Spotlights</span></strong></p>
<p><a name="b"></a><br /><strong>Michigan Adopts Most Innovative Teacher Pension Reform in the Nation</strong></p>
<p>The Michigan Legislature has just passed a first-of-its-kind, innovative pension reform bill that will provide state teachers with a new set of retirement choices and cap the growth of liabilities in the state's current, structurally flawed retirement plan. Should Gov. Rick Snyder sign the bill, the Michigan Public School Employee System (MPSERS)&mdash;currently only 60% funded with $29 billion in unfunded pension liabilities&mdash;will have its most realistic path to solvency in the past two decades.<br /><br />The reform is grounded in a focus on reducing risk, while stabilizing cost, and preserving choice. New hires will be auto-enrolled in a defined contribution (DC) retirement plan with a default 10% total contribution rate. However, if new teachers would prefer a defined benefit (DB) pension plan, they can voluntarily switch to a new "pension plus" plan that uses very conservative assumptions and short amortization schedules and splits all costs 50-50 between the employee and employer. The defined benefit pension plan includes a unique safeguard mechanism that would trigger closure if the funded ratio falls below 85% for two consecutive years. And to top it off, the reform design improves certain actuarial assumptions and infuses the plan with $250 million in additional contributions to chip away at the pension debt.<br /><span style="font-size: 80%; color: red;">&raquo; <a href="http://reason.org/news/show/michigan-teacher-pension-reform">FULL ARTICLE</a></span> <br /><span style="font-size: 80%; color: red;">&raquo; <a href="http://reason.org/MPSERS">MPSERS REFORM ISSUE EXPLAINERS</a></span> <br /><span style="font-size: 80%; color: red;">&raquo; <a href="http://reason.org/files/mpsers_reform_analysis_-_testimony_full_06142017.pdf">TESTIMONY</a></span></p>
<p><span style="font-size: 80%;">[<strong>NOTE</strong>: The Pension Integrity Project at Reason Foundation provided technical assistance to many stakeholders throughout the MPSERS reform process, including the bill sponsors (Sen. Phil Pavlov and Rep. Thomas Albert), legislative leadership in the House and Senate, and many individual legislators. We also provided independent actuarial modeling during the process and offered advice on design concepts to the legislature, the Snyder administration, and the state's Office of Retirement Services.]</span></p>
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<p><a name="c"></a><br /><strong>Pennsylvania Enacts Major Pension Reform</strong></p>
<p>Earlier this month, Pennsylvania Gov. Tom Wolf signed into law pension reform legislation that will offer all new state employees, teachers and school district employees a choice between three different retirement planning options&mdash;a full defined contribution (DC) retirement plan or one of two hybrid plans that combine a DC plan with a smaller defined benefit plan. Reason's Eric Boehm observes that though the reform will not wash away the state's over $70 billion in unfunded liabilities, it makes several critical changes that will lower costs and risks for taxpayers over time. In a letter to legislative leadership, the Pension Integrity Project writes that the reform will &ldquo;ensure that the state is able to offer retirement security to its past, current and future employees on a sustainable basis moving forward.&rdquo;<br /><span style="font-size: 80%; color: red;">&raquo; <a href="http://reason.com/blog/2017/06/12/pennsylvanias-pension-reforms-arent-perf">FULL ARTICLE</a></span> <br /><span style="font-size: 80%; color: red;">&raquo; <a href="http://reason.org/files/letter_reason_pa_pension_reform_2017_turzai.pdf">PENSION INTEGRITY PROJECT LETTER ON PENNSYLVANIA REFORM</a></span></p>
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<p><a name="d"></a><br /><strong>Texas Enacts Dallas, Houston Pension Reform Legislation</strong></p>
<p>The biggest pension crises in the Lone Star State appear to be on a path to resolution, after Texas Gov. Gregg Abbott recently signed bipartisan reform legislation affecting the beleaguered municipal pension systems in Dallas and Houston. For Dallas, the reform legislation aims to fix its ailing Police &amp; Fire Pension System by changing the benefit structure, increasing contributions, and realigning the system's governance. In Houston's case, the reform legislation reduces future benefit accruals, makes a variety of funding policy changes, adopts more conservative actuarial assumptions, caps city contributions, and asks voters to approve $1 billion in pension obligation bonds.<br /><span style="font-size: 80%; color: red;">&raquo;</span><span style="font-size: 80%; color: black;"> ARTICLE:</span><span style="font-size: 80%; color: red;"> <a href="http://reason.org/blog/show/dallas-enacts-pension-reform">Dallas Enacts Pension Reform Legislation</a></span> <br /><span style="font-size: 80%; color: red;">&raquo;</span><span style="font-size: 80%; color: black;"> HOUSTON COVERAGE:</span><span style="font-size: 80%; color: red;"> <a href="http://www.pionline.com/article/20170531/ONLINE/170539972/texas-governor-signs-houston-pension-reform-bill-firefighters-fund-sues-city"><em>Pensions &amp; Investments</em></a> </span><span style="font-size: 80%; color: black;">|</span><span style="font-size: 80%; color: red;"> <a href="https://www.texastribune.org/2017/05/24/house-approves-houston-pension-bill-firefighters-anger-remains/"><em>Texas Tribune</em></a></span></p>
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<p><a name="e"></a><br /><strong>Florida to Default New Hires to Defined Contribution Retirement Plan</strong></p>
<p>The Florida Retirement System currently has $24.9 billion in unfunded pension liabilities that will be borne by taxpayers over the coming decades, and absent major reform, the state's pension debt is likely to continue growing. While the legislature chose not to overhaul the retirement benefit design or deal with the pension debt problem head on this session, it did enact a substantive policy change: nearly all new state employees will default into Florida's previously optional defined contribution (DC) retirement plan, and the current defined benefit plan will become the optional retirement plan. In a recent blog post, Reason's Leonard Gilroy and Spence Purnell write that the move will reduce the financial risk to the state and taxpayers over time as more new workers enter the DC plan, while preserving the ability of new employees to elect to take a traditional pension benefit if they choose.<br /><span style="font-size: 80%; color: red;">&raquo; <a href="http://reason.org/blog/show/florida-defined-contribution">FULL BLOG POST</a></span> <br /><span style="font-size: 80%; color: red;">&raquo;</span><span style="font-size: 80%; color: black;"> RELATED:</span><span style="font-size: 80%; color: red;"> <a href="http://reason.org/blog/show/florida-actuary-pension-investment">Even Their Actuary Thinks Florida's Pension Investment Return Assumption is Wrong</a></span></p>
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<p><a name="i"></a><strong><span style="font-size: 120%;">News Notes</span></strong></p>
<p><strong>New Moody's Report Paints Bleak Picture of Unfunded Public Pension Liabilities</strong>: A new Moody's Investors Service report finds that unfunded pension liabilities for U.S. public pension funds are generally expected to continue to rise through 2020, even under optimistic investment return scenarios. In the rosiest scenario&mdash;assuming a cumulative investment return of 25% between 2017 and 2019&mdash;unfunded liabilities for the 56 public plans analyzed would fall slightly by 1%. By contrast, unfunded liabilities would increase by 15% if cumulative returns totaled 19% over the same period. The full report is <a href="https://www.moodys.com/research/State-and-local-government-US-Pension-burdens-to-rise-through--PBM_1072337">available here</a> (registration required).</p>
<p><strong>New Report Card for State Teacher Pension Systems</strong>: Earlier this month, TeacherPensions.org and Bellwether Education Partners released a new report analyzing the quality of every state's teacher pension plan. The report finds that most states are saddled with costly, debt-laden plans where most teachers fail to qualify for good retirement benefits. A total of 41 states received a failing grade, with 9 others receiving either a "C" or "D." The full report is <a href="https://www.teacherpensions.org/resource/retirement-reality-check-grading-state-teacher-pension-plans">here</a>.</p>
<p><strong>Fitch Adopts More Conservative Pension Risk Calculations</strong>: In a report released earlier this month, Fitch Ratings announced plans to modify the way it calculates defined benefit pension plan liabilities for most state and local governments, lowering its fixed assumed rate of return assumption from 7% to 6%. The move reflects lowered near-term market return expectations amid sluggish economic growth. The Fitch report is <a href="http://www.nasra.org//Files/Topical%20Reports/Credit%20Effects/Fitch1706.pdf">available here</a>.</p>
<p><strong>Mercatus Center Issues New GASB 67/68 Critique</strong>: The Mercatus Center at George Mason University recently released an analysis of the implementation of the GASB 67 and GASB 68 accounting standards, based on a review of 144 public plans. The authors&mdash;Truth in Accounting CEO Sheila Weinberg and Mercatus' Eileen Norcross&mdash;find that while GASB 67/68 were intended to improve the accuracy and transparency of reporting for public sector pension plans, they have had a mixed effect thus far. While the standards more accurately reflect the fiscal health of public plans, there is still room to improve the underlying assumptions used to measure pension obligations. The full report is <a href="https://www.mercatus.org/publications/gasb-67-68-public-pension-reporting">here</a>.</p>
<p><strong>New Society of Actuaries Report Examines Pension Plan Contributions</strong>: A new report from the Society of Actuaries compares actual public pension plan contributions to benchmarks representing the contributions needed to pay down unfunded liabilities for 160 state and municipal pension plans for 2006-2014. Among the findings are that, in 2014, 72% of public plans experienced negative amortization&mdash;when total contributions are insufficient to chip away at unfunded liabilities&mdash;up from 65% in 2006. It also found that total unfunded liabilities rose by 150% over that period, relative to a 76% increase in employer contributions and a 30% increase in employee contributions. The full report is <a href="https://www.soa.org/research-reports/2017/public-pension-indices/">available here</a>.</p>
<p><strong>Census Bureau Issues Annual Public Pension Survey</strong>: The U.S. Census Bureau has released the 2016 data from its annual Survey of Public Pensions, covering public plan revenues, expenditures, financial assets, and membership information across 299 state-level plans and 5,977 local plans. The dataset is available for download <a href="https://www.census.gov/govs/retire/?eml=gd&amp;utm_medium=email&amp;utm_source=govdelivery">here</a>.</p>
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<p><a name="j"></a><strong><span style="font-size: 120%;">Quotable Quotes on Pension Reform</span></strong></p>
<p><br />"It's a better system for new teachers. It's a better system for the taxpayer, and it offers predictability. Hopefully going forward, we'll be able to drive more dollars into the classroom because of the reforms we're working on."<br /><br />&mdash;Michigan State Sen. Phil Pavlov on his recently passed teacher pension reform legislation he sponsored, cited in Jonathan Oosting and Michael Gerstein, "<a href="http://www.detroitnews.com/story/news/politics/2017/06/15/michigan-senate-approves-pension-reform/102887854/">Legislature OKs pension reform over teacher protest</a>," <em>The Detroit News</em>, June 15, 2017.</p>
<p><br />"Government must not write checks and expect the next generation to pick up the tab. This alone will not deal with our pension issues, but it's a start."<br /><br />&mdash;Michigan State Rep. Thomas Albert on the recently passed teacher pension reform legislation he sponsored, cited in Evan Carter, "<a href="https://www.michigancapitolconfidential.com/done-with-school-pension-reform-states-big-pension-liabilities-contained">Done: With School Pension Reform, State's Big Pension Liabilities Contained</a>," <em>Michigan Capitol Confidential</em>, June 20, 2017.</p>
<p><br />"We're like a banana republic. We can't manage our money."<br /><br />&mdash;Illinois Gov. Bruce Rauner, quoted in Brooke Singman, "<a href="http://www.foxnews.com/politics/2017/06/20/illinois-careens-into-financial-meltdown-and-not-even-lottery-is-safe.html">Illinois careens into financial meltdown&mdash;and not even the lottery is safe</a>," FoxNews.com, June 20, 2017.</p>
<p><br />"[California Gov. Jerry] Brown has set a terrible precedent. No doubt his gambit&#8202;&mdash;&#8202;ie, politicians using citizen funds without citizen approval to make investment bets in order to cover up wealth transfers from citizens to employees&#8202;&mdash;&#8202;will be noticed by other elected officials."<br /><br />&mdash;David Crane, "<a href="https://medium.com/&#64;DavidGCrane/california-elects-not-to-pay-down-pension-debt-2b9153f0674f">California Elects Not to Pay Down Pension Debt</a>," Medium.com (blog), June 17, 2017.</p>
<p><br />"For every one police officer, three-quarters of the next police officer is a pension payment. That is a very scary place to be."<br /><br />&mdash;Acting Modesto, CA City Manager Joe Lopez on projections that, in eight years, the city will be paying nearly 72 cents in pension costs for every dollar in police officer salary. Quoted in Kevin Valine, "<a href="http://www.modbee.com/news/article153082744.html">Modesto pension costs expected to skyrocket</a>," <em>Modesto Bee</em>, May 27, 2017.</p>
<p><br />"Imagine having a 30-year mortgage and each year, instead of making your mortgage payments and having 29 years of payments left, you simply re-amortize the remaining liability over another 30-year period [&hellip;] Using this approach, you can manufacture lower amortization payments for yourself, but you will not eliminate the underlying liability [&hellip;] That's called open-ended amortization, and despite being an unscrupulous accounting practice, it is widespread among state pension plans."<br /><br />&mdash;North Carolina State University Assistant Professor Jeff Diebold, quoted in N.C. State University, "<a href="https://news.ncsu.edu/2017/06/pension-plan-liabilities-2017/">Most State Pension Plans Paper Over Unfunded Liabilities</a>" (press release), June 19, 2017.</p>
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<p><a name="k"></a><strong><span style="font-size: 120%;">Contact the Pension Reform Help Desk</span></strong></p>
<p>The Pension Integrity Project's Pension Reform Help Desk provides information and technical resources for those wishing to pursue pension reform in their states, counties and cities. Feel free to contact the Pension Reform Help Desk by e-mail at <a href="mailto:pensionhelpdesk&#64;reason.org">pensionhelpdesk&#64;reason.org</a>.</p>
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<p><em>Follow the discussion on pensions and other governmental reforms at <a href="http://www.reason.org">Reason Foundation's website</a> or on Twitter (<a href="https://twitter.com/ReasonReform?lang=en">&#64;ReasonReform</a>). As we continually strive to improve the publication, please feel free to send your questions, comments and suggestions to <a href="mailto:leonard.gilroy&#64;reason.org">leonard.gilroy&#64;reason.org</a>.</em></p>
<p>Leonard Gilroy<br />Senior Managing Director, Pension Integrity Project<br />Reason Foundation<br /><br />Anthony Randazzo<br />Managing Director, Pension Integrity Project<br />Reason Foundation</p>1014918@http://www.reason.orgThu, 29 Jun 2017 13:20:00 EDTleonard.gilroy@reason.org (Leonard Gilroy)Michigan Adopts Most Innovative Teacher Pension Reform in the Nationhttp://www.reason.org/news/show/michigan-teacher-pension-reform
<p>The Michigan Legislature has passed a first of its kind, innovative pension reform bill that will provide a new set of retirement choices for state teachers and cap the growth of liabilities in the state&rsquo;s current, structurally flawed retirement plan.&nbsp;Gov. Rick Snyder signed the bill into law in July, ensuring the Michigan Public School Employee System (MPSERS)&mdash;currently only 60% funded with $29 billion in unfunded pension liabilities&mdash;will have its most realistic path to solvency in the past two decades.&nbsp;</p>
<p>The reform is grounded in a focus on reducing risk, while stabilizing cost, and preserving choice:</p>
<ul>
<li>New hires will be auto-enrolled in a defined contribution retirement plan (DC Plan) that has a default 10% total contribution rate. DC Plans inherently have no risk of unfunded liabilities, and the maximum employer share for the plan (7%) is less than what employers should be paying for the current plan.</li>
<li>However, if new teachers would prefer a defined benefit pension plan (DB Plan), they will have the choice to voluntarily switch to a new &ldquo;hybrid&rdquo; plan that, unlike the current &ldquo;hybrid&rdquo; plan offered to teachers, uses very conservative assumptions and short amortization schedules and splits all costs 50-50 between the employee and employer.</li>
<li>Uniquely, the hybrid plan will have a safeguard mechanism that would trigger closure if the funded ratio falls below 85% for two consecutive years.</li>
<li>And to top it off, the reform design improves certain actuarial assumptions and infuses the plan with $250 million in additional contributions to chip away at the pension debt.&nbsp;</li>
</ul>
<p>The Pension Integrity Project at Reason Foundation provided technical assistance to many stakeholders throughout the MPSERS reform process, including the bill sponsors (Sen. Phil Pavlov and Rep. Thomas Albert), legislative leadership in the House and Senate, and many individual legislators. We provided independent actuarial modeling during the process and offered advice on design concepts to the legislature, the Snyder administration, and the state&rsquo;s Office of Retirement Services.</p>
<p>Some other plans in the country have adopted similar components as the Michigan teacher pension reform:&nbsp;</p>
<ul>
<li>Florida <a href="http://reason.org/blog/show/florida-defined-contribution">moved</a>&nbsp;to default employees into a DC Plan earlier this year.&nbsp;</li>
<li>Pennsylvania <a href="http://www.pennlive.com/politics/index.ssf/2017/06/gov_tom_wolf_signs_pas_pension.html">overhauled</a>&nbsp;its retirement benefits earlier this month by giving new hires a choice between two hybrids or a DC Plan.&nbsp;</li>
<li>Arizona has <a href="http://reason.org/news/show/az-corrections-pension-reform">embraced</a>&nbsp;50-50 cost sharing for its public safety, state employee, and teacher defined benefit plans.&nbsp;</li>
<li>South Carolina <a href="http://reason.org/blog/show/reviewing-south-carolinas-new-fundi">changed</a>&nbsp;its funded policy to increase employer contribution rates by 100 basis points a year until 2023.</li>
<li>And Kentucky&rsquo;s state and local pension system <a href="http://reason.org/blog/show/kentucky-takes-a-quantum-leap-in-fu">moved</a>&nbsp;to adopt a very conservative 5.25% assumed rate of return last month.&nbsp;</li>
</ul>
<p>But no state in the country thus far has embraced the full scope of these reform components for a teacher pension system in a way that will virtually eliminate the possibility of unfunded liabilities for new hires, while also allowing future teachers a choice of retirement benefit styles (DB or DC). The structure of this blended approach should serve as a model for teacher pension reform in other states facing similar challenges as MPSERS does today.&nbsp;</p>
<p>&nbsp; &nbsp; &nbsp;&nbsp;</p>
<p><strong>1. The Problem</strong></p>
<p>Like many other pension systems in America, MPSERS faces a mountain of unfunded liabilities and future of growing contribution rates. At the turn of the millennium the Michigan teachers plan was reported to be fully funded, but as of the end of last year (June 2016) the plan&rsquo;s funded ratio was below 60% with $29.1 billion in unfunded liabilities.</p>
<p><img style="float: right;" src="/files/pensions/MPSERS/MPSERS_UAL.jpg" alt="UAL Causes for MPSERS" width="320" height="240" />Our analysis of the MPSERS valuation reports found that two-thirds of the debt accrual came from underperforming assets over the past decade and a half. For the past few decades MPSERS has assumed an 8% rate of return on assets. However, the 20-year average return has actually been 7.2%. The 15-year average is even worse at 6.5%, while the 10-year return has been just 5.8%. &nbsp;</p>
<p>Other actuarial assumptions have created problems for MPSERS too. For example, since 2004, the Michigan Office of Retirement Services (ORS) has been assuming a 3.5% growth in payroll &mdash; but there hasn&rsquo;t been a single year since then that payroll grew at that rate higher than 1.25%. In fact, over the past 15 years the payroll for the plan has actually declined by nearly $2 billion. This grossly unrealistic growth assumption &mdash; combined with a long, level-percent of payroll amortization method &mdash; has effectively back-loaded billions in unfunded liability payments, making the long-term &ldquo;plan&rdquo; to pay off the pension debt increasingly a fantasy.&nbsp;</p>
<p>In 2010, Michigan created a new &ldquo;Pension Plus Plan&rdquo; to replace its existing defined benefit plan for future hires. This new hybrid design included the same defined benefit plan &mdash; with a 1.25% multiplier, 10-year vesting schedule, and 5-year final average salary &mdash; but with a larger employee contribution, slightly changed retirement eligibility age, and no cost-of-living adjustment. Instead of a COLA, the state added a small DC Plan on the side of the DB Plan, with a 1% maximum employer match for the first 2% contributed by the employee. Most importantly, this &ldquo;hybrid&rdquo; plan was priced with a 7% assumed rate of return while the main DB Plan continued to use an 8% rate of return.</p>
<p>This change was not enough to fix MPSERS&rsquo; problems though. Even the 7% assumed return carried substantial risk. We developed a Monte Carlo analysis of the MPSERS portfolio using asset class forecasts by three leading financial firms plus the Michigan Bureau of Investment&rsquo;s own forecasts and found that there was <a href="http://reason.org:8080/files/onepager_mpsers_03_assumedreturneffects_sourced.pdf">less than</a>&nbsp;a 50% chance of achieving a 7% rate of return.&nbsp;</p>
<p>To make matters worse, all of the other unrealistic or inaccurate assumptions being used by MPSERS for the old plan were the same for the Pension Plus hybrid plan. As a result, employers contributed just 3.1% towards the post-2010 defined benefit plan when <a href="http://reason.org/files/onepager_mpsers_05_hybrid81.pdf">more realistic assumptions</a>&nbsp;would have required around 7.1% employer contributions.</p>
<p>Meanwhile pension debt continued to accrue in the old plan with its unrealistic 8% assumed return. The adoption of the hybrid plan didn&rsquo;t fix the problem, and its actuarial assumptions were tacitly underfunding new employee retirement benefits in just the same ways as the old plan.&nbsp;</p>
<p>On top of growing unfunded liabilities, MPSERS has also faced considerable retention problems. Our analysis of termination data provided by ORS found that about 50% of teachers left before vesting in any benefit, and less than a third of teachers actually stayed long enough (30 years) to earn a full pension benefit. The existing system was clearly not working for all teachers.&nbsp;</p>
<p>Using independent actuarial modeling we built for members of the Michigan legislature, our forecast shows that without changes to MPSERS and continuation of recent actuarial experience trends, actuarially required employer contributions would effectively double by the 2030s, from around 30% of payroll today to north of 60% of payroll. Such a nightmare scenario would easily risk crowding out classroom expenditures as all of Michigan education costs &mdash; including pension debt costs &mdash; come from the same pot of money in the Michigan budget called the School Aid Fund. Facing this kind of unsustainable future, the Michigan legislature knew it needed to act. &nbsp;</p>
<p>&nbsp; &nbsp; &nbsp; &nbsp; &nbsp;</p>
<p>&nbsp;</p>
<p><strong>2. The Solution</strong></p>
<p>The primary objectives of pension reform in Michigan started with ensuring that all promises made to existing employees and retirees could be kept, and that any solution ensure retirement security for all current and future members. A major focus was on putting a cap on the state&rsquo;s financial risk while also minimizing increases in normal cost. It was important for many stakeholders in Michigan that employees have the option for a traditional defined benefit, while other stakeholders were focused on providing a robust DC Plan that would provide portable benefits for the more mobile teachers in the state. The final agreement balanced the varying interests and goals of stakeholders from across the legislature and Governor&rsquo;s office.&nbsp;</p>
<p><span style="text-decoration: underline;">Retirement Benefit Design</span>&nbsp;</p>
<p><em>Future Members</em> &mdash;&nbsp;</p>
<ul>
<li><strong>DC Default Plan:</strong> All new hires as of&nbsp;February 1, 2018 will be automatically defaulted into a DC Plan that has a 4% minimum employer contribution and up to 3% more in matching employer contributions.&nbsp;</li>
<li><strong>Full Match Auto-enroll:&nbsp;</strong>Employees will be auto enrolled with a 3% contribution to receive the full employer match, resulting in a default 10% DC plan. Employees will have their contributions automatically increased by 1% each year up to 7% total employee contributions, but always have the right to voluntarily reduce the contribution back down to whatever their preference. Cumulatively, this means that within 4-years of membership, a teacher would be fully vested in a 14% DC Plan, a level that will provide for a robust retirement benefit. &nbsp;</li>
<li><strong>Pension Plus 50-50 Plan:&nbsp;</strong>All new hires as of February 1, 2018 will have the option to choose a new, de-risked &ldquo;hybrid" plan. They will have 75 days to make this election and will be presented with information about both the DC Plan and hybrid plan. Employees making the election will need to acknowledge receipt of this information with a signature to ensure they are being properly educated about their decision. (See below for details on the&nbsp;Pension Plus 50-50 Plan design.)&nbsp;</li>
</ul>
<p><em>Current Members</em> &mdash;</p>
<ul>
<li><strong>Upgrade Current DC Members:</strong> Teachers who had selected a DC only plan first available in 2012, but that only had a 3% employer contribution will be upgraded to the more generous DC Plan created under this pension reform with an up to 7% employer contribution.&nbsp;</li>
<li><strong>Retirement Age Linked to Mortality:</strong> For teachers in the existing (and new) hybrid plan, their retirement age will be subject to increase should there be a meaningful change to mortality tables. For each year in additional life expectancy relative to 2017 assumptions, the board will increase the retirement age one or two years as necessary.&nbsp;</li>
<li><strong>Offer Annuities:</strong> The Michigan Treasury department, which manages the existing DC Plan that is primarily used by state employees, will be required to add to its mix of investment options that are provided by a third-party vendor at least one fixed rate annuity, and at least one variable rate annuity. This is intended to provide options at retirement for plan members.</li>
</ul>
<p><span style="text-decoration: underline;">Funding Policy Improvements for the Existing Plan</span>: While the primary changes of the Michigan teacher pension reform were a cap on liabilities and improved benefit design structure, there were also&nbsp;funding policy changes that cumulatively will result in approximately $250 million in the current year budget being&nbsp;appropriated to make a down payment on the existing debt above and beyond the actuarially determined contribution.</p>
<p><em>Assumption Changes &mdash;</em></p>
<ul>
<li><strong>Assumed Return:</strong> Earlier this year the state decided to lower the assumed rate of return for the &ldquo;Basic&rdquo; pre-2010 defined benefit plan (which has most of the MPSERS accrued liabilities) from 8% to 7.5%. Technically, the funding for this change was included in a separate appropriations bill, but the agreement to embrace the change and fund it was part of the overall conceptual approach to funding policy reform whereby the state will periodically start reducing its rate of return. The next reduction will likely accompany a MPSERS actuarial experience study scheduled for 2018.</li>
<li><strong>Adjusted Payroll:</strong> Change the basis of the amortization schedule from covered payroll to current operating expenditures of a school district; the underlying assumption does not change in this bill but will be lowered in next year&rsquo;s actuarial experience study, which involves a deep analysis of all assumptions used by the plan compared to actual historic performance with the goal of proposing adjustments to improve funding.</li>
</ul>
<p>&nbsp;<em>Method Changes &mdash;</em></p>
<ul>
<li><strong>No Normal Cost&nbsp;&ldquo;Credits&rdquo;:&nbsp;</strong>The normal cost in any given year cannot be reduced due to reported &ldquo;overfunding&rdquo;</li>
<li><strong>Contribution Rate Floor:</strong> The unfunded liability amortization payment in any given year cannot be less than the prior year until the plan is fully funded</li>
</ul>
<p>&nbsp;<em>Transparency Improvements &mdash;&nbsp;</em></p>
<ul>
<li><strong>Probability of Return Study:</strong> The Michigan Treasury department will be required to produce a report along with the MPSERS experience study that shows the various probable rates for return for the existing portfolio, i.e. the probable rate of return at the 5th percentile, 25th percentile, etc. &nbsp;</li>
</ul>
<p><span style="text-decoration: underline;">New Pension Plus 50-50 Plan Design</span>: A key innovation in the Michigan teacher pension reform is the creation of a retirement option that combines a de-risked defined benefit pension plan with a defined contribution retirement plan.</p>
<p><em>Improved Cost Sharing and Methods &mdash;</em></p>
<ul>
<li>All normal costs and any potential unfunded liability amortization payments necessary for this tier are split 50-50 between the employers and employees</li>
<li>6% assumed rate of return</li>
<li>10-year, level-dollar amortization schedules on a layered basis</li>
</ul>
<p><em>Defined Benefit Plan &mdash;</em></p>
<ul>
<li>1.25% multiplier and 5-year final average compensation</li>
<li>10-year vesting</li>
<li>Retirement Eligibility: Age 60 with 10 years of service</li>
</ul>
<p><em>Defined Contribution Plan</em> &mdash;</p>
<ul>
<li>Employer match of 50% of employee contributions with a maximum of 1%</li>
<li>Employees defaulted at 2% contribution to receive the full match, but can reduce or increase their rate</li>
</ul>
<p><em>Catastrophic Downturn Safeguard Mechanism &nbsp;&mdash;</em></p>
<ul>
<li>If the funded ratio for the new hybrid plan falls below 85% for two consecutive years, then the plan will be closed to new hires within 12 months following the actuarial valuation showing the second year of 85% or less funding</li>
<li>The funded ratio is measured on an actuarial value using 5-year smoothing</li>
<li>Explicit underfunding by the legislature (i.e., failing to pay the actuarially determined rate) to try and trigger closing will not be counted towards the 85% funded ratio&nbsp;</li>
</ul>
<p>&nbsp; &nbsp; &nbsp; &nbsp;</p>
<p><strong>3. Pension Integrity Project&rsquo;s Role</strong></p>
<p>Our Pension Integrity Project team provided technical assistance to many stakeholders in the MPSERS reform process. We provided independent actuarial modeling for members of the state House and Senate (including, most importantly, the bill sponsors), as well as policy design advice to legislative leadership, governor's office, and the state&rsquo;s Office of Retirement Services based on our experience assisting in other states. Whenever we look at a proposed pension reform package we always compare it <a href="http://reason.org:8080/files/pensionintegrityproject_about.pdf">our objectives</a>&nbsp;for good pension reform. Ultimately, the MPSERS reform bill compared very favorably to our matrix:</p>
<ul>
<li><strong>Keeping Promises:</strong>&nbsp;The adopted legislation will help to improve the solvency of MPSERS by gradually, but dramatically, reducing the possibility of unfunded liabilities, which will help ensure the state&rsquo;s ability to live up to its pension promises. No part of the proposed legislation takes away any retirement benefit from any member or retiree.</li>
<li><strong>Provide Retirement Security:</strong> The reform will make it easier to pay off unfunded liabilities in the long-run and ensure 100% funding for promised benefits. The DC Plan provides a competitive retirement benefit modeled after the same plan all new state employees in Michigan have received since 1997. And the Pension Plus 50-50 Plan preserves the option for a traditional pension for those that want it &mdash; and are willing to contribute more to pay for it.</li>
<li><strong>Stabilize Contribution Rates:</strong> The current Pension Plus Plan does not have stable rates because it is using mostly the same faulty actuarial assumptions as the old legacy defined benefit plan closed in 2010. The proposed DC retirement plan would have no volatility for new hire benefits, creating fixed costs in the long-term. Plus, the new hybrid plan would have equal cost sharing with short amortization schedules, minimizing the potential for contribution rate volatility.</li>
<li><strong>Reduce Risk:</strong> The reform package will result in the gradual reduction in taxpayer-guaranteed pension benefits, which will mean a gradual reduction in risk exposure because there will be fewer promises exposed to potential underfunding.</li>
<li><strong>Reduce Long-Term Costs:</strong> The current employer contribution forecasts for the Pension Plus Plan of around 3.1% for the defined benefit portion are underpricing the actual costs of that benefit. The new Pension Plus 50-50 Plan design would mean a slightly higher employer contribution to retirement benefits (an estimated 5-6%) compared to the current forecast &mdash; however, compared to a realistic pricing on the current plan (around 7%), the new plan is cheaper. Plus, because there is much less possibility to accrue unfunded liabilities under the adopted reform, it means that long-term costs are going to be lower because of the changes.&nbsp;</li>
<li><strong>Ensure Ability to Recruit/Retain:</strong> DC Plans are portable and have flexible contribution rates, making them an attractive option for certain employees. The ability to adjust rates based on an individuals own retirement goals while also receiving a generous employer contribution (7%) make the new DC Plan more attractive than previous options for teachers. Having a choice of benefit makes the new plan even more attractive from a recruitment perspective too.&nbsp;</li>
</ul>
<p>The Michigan Legislature should be congratulated for adopting such an innovative teacher pension reform package that will reduce risk, provide choice, stabilize contribution rates, offer retirement security, and keep promises. Other states and cities should look to this design for inspiration in solving their similar pension woes.</p>
<p><strong>Additional Resources</strong>:</p>
<ul>
<li>Full text and legislative history: <a href="http://legislature.mi.gov/doc.aspx?2017-SB-0401">Senate Bill 401 &amp; House Bill 4647</a>&nbsp;(mirror bills)</li>
<li>Pension Integrity Project&rsquo;s MPSERS reform fact sheets and issue explainers: <a href="http://reason.org/MPSERS">reason.org/MPSERS</a></li>
<li>Pension Integrity Project 6/14/2017 <a href="http://reason.org/files/mpsers_reform_analysis_-_testimony_full_06142017.pdf">testimony</a>&nbsp;to the House and Senate Education Committees (includes our complete actuarial analysis of MPSERS and detailed analysis of the adopted changes)</li>
<li>Additional <a href="http://reason.org:8080/files/pensionintegrityproject_about.pdf">Pension Integrity Project</a>&nbsp;information</li>
</ul>1014914@http://www.reason.orgFri, 16 Jun 2017 11:30:00 EDTanthony.randazzo@reason.org (Anthony Randazzo)Pension Reform Newsletter - May 2017http://www.reason.org/news/show/pension-reform-newsletter-may17
<p>This newsletter from Reason Foundation's Pension Integrity Project highlights articles, research, opinion, and other information related to public pension challenges and reform efforts across the nation. You can find previous editions <a href="http://reason.org/newsletters/pensionreform/">here</a>.</p>
<p><strong><span style="font-size: 120%;">In This Issue:</span></strong></p>
<p><strong><a href="#a">Articles, Research &amp; Spotlights</a></strong></p>
<ul type="disc">
<li><a href="#b">Arizona Reforms Second Public Safety Pension Plan</a></li>
<li><a href="#c">South Carolina Adopts New Funding Policy</a></li>
<li><a href="#d">In Defense of Full Pension Funding</a></li>
<li><a href="#e">IMF Report Predicts Slow Productivity Growth in Years to Come</a></li>
</ul>
<p><strong><a href="#i">News Notes</a></strong></p>
<p><strong><a href="#j">Quotable Quotes on Pension Reform</a></strong></p>
<p><strong><a href="#k">Contact the Pension Reform Help Desk</a></strong></p>
<hr />
<p><a name="a"></a><strong><span style="font-size: 120%;">Articles, Research &amp; Spotlights</span></strong></p>
<p><a name="b"></a><br /><strong>Arizona Reforms Second Public Safety Pension Plan</strong></p>
<p>Arizona recently enacted pension reform legislation that will put Arizona's struggling Corrections Officer Retirement Plan (CORP)&mdash;which has accumulated at least $1.4 billion in unfunded liabilities since 2000 and stands at only 53% funded today&mdash;on a path to financial solvency. The CORP reform is expected to shift approximately 90% of new hires into a defined contribution retirement plan and nearly eliminate the potential for new unfunded liabilities once the current pension debt is paid off.<br /><br />The reform had strong bipartisan support in the legislature and garnered the support of public safety associations, employers, and taxpayer advocates. The Pension Integrity Project at Reason Foundation assisted in the collaborative process by developing and analyzing reform options and serving as an intermediary negotiator between the legislature, labor groups, and employer representatives.<br /><br />That a comprehensive pension reform could attract such a diverse group of stakeholder supporters is noteworthy on its own. Even more important is that the CORP pension reform marks the completion of a two-year, bi-partisan process of overhauling retirement benefits for all public safety employees in Arizona. Taken together, these reforms demonstrate that a collaborative, stakeholder engagement process can successfully deliver substantive policy change without the typical political divisiveness often seen in pension reform debates.<br /><span style="font-size: 80%; color: red;">&raquo; <a href="http://reason.org/news/show/az-corrections-pension-reform">FULL ARTICLE</a></span> <br /><span style="font-size: 80%; color: red;">&raquo; <a href="http://reason.org/files/az_corp_reform_analysis_2017apr17_[final].pdf">PRESENTATION: Analysis of Arizona CORP Pension System and Reform (April 2017)</a></span></p>
<p><span style="font-size: 80%;">[<strong>NOTE</strong>: The Pension Integrity Project at Reason Foundation played a central role in designing the policy option set, providing actuarial analysis of proposed reform concepts, and negotiating the final enacted reform. For more information about the CORP reform process, contact Reason's <a href="mailto:leonard.gilroy&#64;reason.org">Leonard Gilroy</a>.]</span></p>
<p><span style="font-size: 80%;">&raquo; <a href="#top">return to top</a></span></p>
<hr />
<p><a name="c"></a><br /><strong>South Carolina Adopts New Funding Policy</strong></p>
<p>Last month South Carolina enacted a law that will increase employer contributions into the South Carolina Retirement System (SCRS) and Police Officers Retirement System (PORS), the two largest public pension plans in the state. According to Reason's Anthony Randazzo and Anil Niraula, these plans will be better off with the funding policy changes relative to the status quo, but more reform work still needs to be done to put South Carolina on a true path to sustainability and solvency.<br /><span style="font-size: 80%; color: red;">&raquo; <a href="http://reason.org/blog/show/reviewing-south-carolinas-new-fundi">FULL ARTICLE</a></span> <br /><span style="font-size: 80%; color: red;">&raquo; <a href="http://reason.org/files/south_carolina_scrs_pension_reform_analysis_2016oct25.pdf">TESTIMONY: South Carolina Pension Analysis (Oct 2016)</a></span> <br /><span style="font-size: 80%; color: red;">&raquo; <a href="http://reason.org/files/onepager_scrs_newplanneeded_sources.pdf">EXPLAINER: Why South Carolina Needs a New Retirement Plan for Future Hires</a></span> <br /><span style="font-size: 80%; color: red;">&raquo; <a href="http://reason.org/files/onepager_scrs_mythsnewhires.pdf">EXPLAINER: Why New Hires Are Not Necessary to Fully Fund the SCRS Pension Plan</a></span></p>
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<hr />
<p><a name="d"></a><br /><strong>In Defense of Full Pension Funding</strong></p>
<p>A recent report by the Haas Institute at the University of California, Berkeley asserts that the public pension crisis is overblown and that public sector retirement systems are really just victims of overzealous Government Accounting Standards Board rules related to reporting risk. The report further contends that it is wrong to treat permanent governments like private companies that may shut their doors because this creates avoidable financial pressures on government employers. In a recent Forbes.com article, Reason's Anthony Randazzo and Leonard Gilroy find that this report, while a thoughtful and nuanced critique, seeks to upend pension accounting in ways that would&mdash;counter to its intention&mdash;jeopardize retirement security for public employees, not enhance it.<br /><span style="font-size: 80%; color: red;">&raquo; <a href="https://www.forbes.com/sites/realspin/2017/04/06/retirement-security-requires-fully-funding-public-pension-plans/#b7d5f9cb7d5f">FULL ARTICLE</a></span></p>
<p><span style="font-size: 80%;">&raquo; <a href="#top">return to top</a></span></p>
<hr />
<p><a name="e"></a><br /><strong>IMF Report Predicts Slow Productivity Growth in Years to Come</strong></p>
<p>A new report by the International Monetary Fund outlines a pessimistic view for global productivity in the near- and medium-term future. In short, productivity growth is more likely to slow down than increase in the coming years due to demographic changes, underinvestment in human capital, and a lack of innovation. According to Reason's Daniel Takash, the lack of innovation and productivity growth means overall growth in investment returns will likely be sluggish for the foreseeable future.<br /><span style="font-size: 80%; color: red;">&raquo; <a href="http://reason.org/blog/show/imf-gone-with-the-headwinds">FULL ARTICLE</a></span></p>
<p><span style="font-size: 80%;">&raquo; <a href="#top">return to top</a></span></p>
<hr />
<p><a name="i"></a><strong><span style="font-size: 120%;">News Notes</span></strong></p>
<p><strong>New Hoover Institution Report Finds $3.8 Trillion in Unfunded State and Local Pension Liabilities</strong>: The Hoover Institution recently released its annual report on pensions&mdash;<a href="http://www.hoover.org/news/hoover-institution-releases-2017-study-highlighting-unfunded-liabilities-state-and-local"><em>Hidden Debt, Hidden Deficits</em></a>&mdash;which found that total unfunded pension liabilities rose to $3.85 trillion in 2015, which is approximately $434 billion more than the previous year and more than double the amount that is officially recognized by the pension plans. The report also found that pension systems saw average investment returns of only 2.87% in 2015, relative to an average discount rate of 7.36%. The report, which covered 649 U.S. public pension systems, is <a href="http://www.hoover.org/news/hoover-institution-releases-2017-study-highlighting-unfunded-liabilities-state-and-local">available here</a>.</p>
<p><strong>New Pew Report Finds $1.1 Trillion in Unfunded State Pension Liabilities</strong>: The Pew Charitable Trusts recently released their annual report on state pension funding&mdash;<em>The State Pension Funding Gap: 2015</em>&mdash;finding that unfunded pension liabilities reached $1.1 trillion in fiscal year 2015, an increase of $157 billion (17%) over 2014 levels. Further, the aggregate funded ratio of these pension plans was 72% in 2015, down from 75% the previous year. The full report is <a href="http://www.pewtrusts.org/en/research-and-analysis/issue-briefs/2017/04/the-state-pension-funding-gap-2015">available here</a>.</p>
<p><strong>Analysis: Pension Benefits Not Helping Teacher Retention</strong>: In a <a href="http://educationnext.org/why-most-teachers-get-bad-deal-pensions-state-plans-winners-losers/">new <em>Education Next</em> article</a>, Chad Aldeman and Kelly Robson at Bellwether Education Partners reviewed teacher pension plans in all 50 states, comparing the share of employees that vest in their employer contributions, as well as the share that fulfill the requirements to receive full pension benefits. Examining teacher pension plans&rsquo; assumptions, they found that on average, over 50% of teachers do not receive any employer pension benefits because they leave before they are eligible, and only one in five stays on the job long enough to receive full benefits at retirement. The full analysis and 50-state breakdown is <a href="http://educationnext.org/why-most-teachers-get-bad-deal-pensions-state-plans-winners-losers/">here</a>.</p>
<p><span style="font-size: 80%;">&raquo; <a href="#top">return to top</a></span></p>
<hr />
<p><a name="j"></a><strong><span style="font-size: 120%;">Quotable Quotes on Pension Reform</span></strong></p>
<p><br />"Return now to what's wrong with the financial management of public pensions in the United States. It boils down to this: the plans, as currently managed, do not account for the cost of investment risk. As a result, the true cost of providing a secure pension benefit is more than what is reported, so funding is insufficient.<br /><br />This means benefit payments down the road will depend to a significant degree on the ability of future governments to make up potentially significant shortfalls. The money incorrectly thought saved in smaller government contributions today is just the unaccounted-for market price of risk. That leaves the risk itself to be borne by someone in the future."<br /><br />&mdash;Ed Bartholomew, "<a href="http://www.milkenreview.org/articles/public-pension-plans?IssueID=23">Public Pension Plans</a>," <em>Milken Institute Review</em>, April 28, 2017.</p>
<p><br />"As the astute reader will infer, employees profit from the highest possible investment return assumption being used by CalPERS to set Normal Costs. The higher that rate, the lower the Normal Cost, which is their only cost. But the higher that rate, the greater the likelihood of Unfunded Liabilities. Because public employees control CalPERS, investment return assumption rates have been set at levels virtually guaranteeing the creation of Unfunded Liabilities. <strong><em>That transfers wealth from citizens to employees</em></strong>. The transfer has been huge: citizens are already on the hook for $60 billion of Unfunded Liabilities for state employee pensions accruing interest at 7.5% per year and more transfers are occurring every day CalPERS continues setting Normal Costs unfairly low."<br /><br />&mdash;David Crane, "<a href="https://medium.com/&#64;DavidGCrane/california-cover-up-f47b517ab2d0">California Cover Up</a>," Medium.com (blog), May 19, 2017.</p>
<p><br />"[S]tates should stop trying to use pension plans as a tool to shape their workforce and instead think of them as a source of retirement benefits for a large and important class of workers. A close look at the financial assumptions that undergird their plans shows that the states themselves don't believe these incentives are effective at retaining teachers; in fact, they count on high rates of teacher turnover in order to balance the books. Focusing instead on offering retirement plans that provide all teachers the opportunity to accrue adequate benefits would be a more realistic and equitable approach."<br /><br />&mdash;Chad Aldeman and Kelly Robson, "<a href="http://educationnext.org/why-most-teachers-get-bad-deal-pensions-state-plans-winners-losers/">Why Most Teachers Get a Bad Deal on Pensions</a>," EducationNext.com, May 16, 2017.</p>
<p><br />"Our elected officials must heed the advice of pension fund managers, respect the evidence and reject divestment of California public monies [from companies involved with the Dakota Access Pipeline project]. Decisions affecting California's pension funds must be guided solely by what is best for the monies under their management. Anything less will hurt retirees, taxpayers and businesses."<br /><br />&mdash;Carlos Solorzano, CEO of the Hispanic Chambers of Commerce of San Francisco, "<a href="http://www.sfchronicle.com/opinion/openforum/article/Divestment-from-California-public-pension-funds-11069482.php">Divestment from California public pension funds is bad for pensioners</a>," <em>San Francisco Chronicle</em>, April 12, 2017.</p>
<p><br />"[T]axpayers have a right to decide how much they're willing to spend on the people employed by their municipality or state. Hiding the true cost of that compensation by lowering the pension funding requirements -- while simultaneously relying on an unpriced, undisclosed call option on their future earnings to make the math work -- is both unfair and undemocratic."<br /><br />&mdash;Megan McArdle, "<a href="https://www.bloomberg.com/view/articles/2017-04-11/don-t-mess-around-with-government-pensions">Don't Mess Around With Government Pensions</a>," <em>Bloomberg View</em>, April 11, 2017.</p>
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<hr />
<p><a name="k"></a><strong><span style="font-size: 120%;">Contact the Pension Reform Help Desk</span></strong></p>
<p>Reason Foundation's Pension Reform Help Desk provides information and technical resources for those wishing to pursue pension reform in their states, counties and cities. Feel free to contact the Reason Pension Reform Help Desk by e-mail at <a href="mailto:pensionhelpdesk&#64;reason.org">pensionhelpdesk&#64;reason.org</a>.</p>
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<hr />
<p><em>Follow the discussion on pensions and other governmental reforms at <a href="http://www.reason.org">Reason Foundation's website</a> or on Twitter (<a href="https://twitter.com/ReasonReform?lang=en">&#64;ReasonReform</a>). As we continually strive to improve the publication, please feel free to send your questions, comments and suggestions to <a href="mailto:leonard.gilroy&#64;reason.org">leonard.gilroy&#64;reason.org</a>.</em></p>
<p>Leonard Gilroy<br />Senior Managing Director, Pension Integrity Project<br />Reason Foundation<br /><br />Anthony Randazzo<br />Managing Director, Pension Integrity Project<br />Reason Foundation</p>1014895@http://www.reason.orgFri, 26 May 2017 14:59:00 EDTleonard.gilroy@reason.org (Leonard Gilroy)Arizona Reforms Second Public Safety Pension Plan http://www.reason.org/news/show/az-corrections-pension-reform
<p>Arizona Gov. Doug Ducey signed into law today pension reform legislation (<a href="https://apps.azleg.gov/BillStatus/BillOverview/69286">Senate Bill 1442</a>) that will put Arizona's struggling Corrections Officer Retirement Plan (CORP) on a path to financial solvency. CORP covers all state and local corrections, detention and probation officers statewide, but has accumulated at least $1.4 billion in unfunded liabilities since 2000 and stands at only 53% funded today.</p>
<p>The CORP pension reform follows&mdash;and shares some common features with&mdash;the <a href="http://reason.org/news/show/az-public-safety-pension-reform">successful reform of the state's Public Safety Personnel Retirement System (PSPRS) last year</a>:</p>
<ul>
<li>Both reforms replace a broken permanent benefit increase (PBI) mechanism with a traditional cost of living adjustment (COLA) tied to inflation. The post-retirement PBI was problematically funded from skimming assets off the top of good investment years and was a key factor driving the growth in CORP&rsquo;s unfunded liabilities.</li>
<li>Both reforms created new retirement plan designs for future public safety personnel that will provide better retirement security for employees while minimizing financial risks to taxpayers.</li>
<li>Both reforms provide new hires for typically full career public safety positions with the choice between a fully funded defined benefit (DB) plan or a professionally managed defined contribution (DC) retirement plan.</li>
<li>In a unique feature, the CORP reform also provides a portable, professionally managed defined contribution retirement plan for corrections officers that historically have experienced significant turnover, ensuring that all employees have access to secure retirement savings.</li>
</ul>
<p>Combined, the CORP pension reform effort is expected to shift approximately 90% of new hires into a DC retirement plan and nearly eliminate the potential for new unfunded liabilities once the current pension debt is paid off.</p>
<p>The CORP reform legislation had strong bipartisan support&mdash;passing the House of Representatives overwhelmingly with a 53-4 vote, and the Senate by a 23-7 vote. This overwhelming support was possible largely due to the fact it is the negotiated result of a 6-month, collaborative stakeholder process launched by State Senate President Pro Tem Debbie Lesko that ultimately garnered the support of a wide range of stakeholders, including public safety associations, employers, and taxpayer advocates.</p>
<p>Like the PSPRS reform in 2016, the Pension Integrity Project at Reason Foundation played a central role in designing policy options and negotiating the final reform. Our project team provided education, policy options, and actuarial analysis for stakeholders throughout the process, and we helped facilitate a consensus among stakeholders on the conceptual design and other parameters of the reform.</p>
<p>Key public safety associations were active in the stakeholder discussions&mdash;specifically the Arizona Police Association, the Consolidated Law Enforcement Associations of Arizona, and the Arizona Police Officer Association&mdash;and ultimately supported the CORP reform package in the interest of improving the plan's solvency and putting a sustainable retirement system in place for the future. Additionally, the state lodge of the Fraternal Order of Police took a neutral position on the main reform legislation (SB 1442), but supported the companion legislation (<a href="https://apps.azleg.gov/BillStatus/BillOverview/69212">Senate Concurrent Resolution 1023</a>) that refers a constitutional amendment related to the PBI-to-COLA change to the ballot.</p>
<p>Other organizations supporting CORP reform include the County Supervisors Association of Arizona, Goldwater Institute, Americans for Prosperity-Arizona, Arizona Free Enterprise Club, and Retirement Security Initiative.</p>
<p>That a comprehensive pension reform could attract such a diverse group of stakeholder supporters is noteworthy on its own. Even more important is that the CORP pension reform marks the completion of a two-year bi-partisan process of overhauling retirement benefits for all public safety employees in Arizona. The CORP and PSPRS reforms together offer evidence that a collaborative, stakeholder engagement process can successfully deliver substantive policy change without the typical political divisiveness often seen in pension reform debates.</p>
<p><strong>The Need for Reform</strong></p>
<p><a href="/files/corpfundedstatus.png" target="_blank"><img src="/files/corpfundedstatus.png" alt="" width="250" align="right" border="1" /></a>CORP's degrading solvency since 2000 has led to dramatic increases in annual pension costs for state and local agency employers participating in CORP&mdash;total employer contribution rates increased from 3.2% to 18.2% over the last 15 years&mdash;which have largely been driven by rising payments to cover the plan&rsquo;s $1.4 billion in unfunded liabilities. For employers, the growth of these pension debt payments is effectively crowding out other public services and areas of the budget, making it ever more difficult to hire new corrections officers and make pay more competitive. Further, the courts have struck down several previous pension reforms enacted in recent years, and other reforms remain under litigation, creating the need for a new solution.</p>
<p>The two biggest factors influencing CORP's decline have been: (1) the system's current permanent benefit increase mechanism (PBI), and (2) underperforming investment returns.</p>
<p>The PBI mechanism has undermined CORP's solvency by skimming assets off the top of the fund in years of good market performance and paying them out as permanent benefit increases to retirees over time to partially offset inflation. Among the problems associated with the PBI:</p>
<ul>
<li>For most retirees today, half of CORP's annual investment returns over 9% (mistakenly deemed &ldquo;excess&rdquo; returns) are diverted to a separate fund to pay out PBI benefits. Thus, these funds cannot be cannot earn interest over time and cannot be used to reduce unfunded liabilities, effectively constraining the growth of CORP's assets.</li>
<li>One-time high market returns were used to justify permanent benefit increases on an ongoing basis.</li>
<li>PBI benefits are not directly linked to inflation and are dependent upon investment returns, making it a poor method of adjusting retiree benefit levels to keep up with actual changes in the costs of living.</li>
<li>Until recently, the PBI benefit had not been pre-funded like a traditional cost of living adjustment (COLA) used by many pension systems. In recent years, the PSPRS board (which also governs CORP) has begun requiring employers to make an additional contribution to offset some of the PBI's skimming effects.</li>
</ul>
<p>Given current market conditions and future market forecasts, it is doubtful whether retirees would receive future PBI distributions on a regular basis. Until two years ago when the PBI account ran dry, most CORP retirees had received a PBI benefit for well over a decade, despite the continuing decline in CORP's funding status. Now that the PBI account is empty, the plan would need to have several years of very strong returns for retirees to receive a full PBI.</p>
<p>In addition to the PBI problem, CORP has seen underperforming investment returns relative to its assumed rate of return.</p>
<p><a href="/files/corpreturns.png" target="_blank"><img src="/files/corpreturns.png" alt="" width="250" align="right" border="1" /></a>Over the past 25 years actuaries made recommended contribution rates based on assumed investment returns of between 7.4% to 9%, depending on the year. However, the plan's average market return since 1993 is just 6.2%, and the average market return over the past 15 years is a dismal 4.4%. CORP's assets are commingled and invested together with PSPRS, and thus the plan has wrestled through the same challenges of increased volatility in rates of return as the investment portfolio has decreased the lower-risk fixed income allocation and increased the amount of equities and alternatives. The chase for yield has not been particularly successful however, and the average actuarially valued return since 2002 has been just 4.3%.</p>
<p><strong>Goals of Reform</strong></p>
<p>The primary goals of the CORP reform included:</p>
<ul>
<li>Providing retirement security for all retirees and employees (current and future)</li>
<li>Stabilizing contribution rates for the long-term</li>
<li>Reducing taxpayer and pension system exposure to financial risk and market volatility</li>
<li>Reducing long-term costs for both employers/taxpayers and employees</li>
<li>Ensuring government employers&rsquo; ability to recruit 21st Century employees</li>
</ul>
<p><strong>Reform Overview</strong></p>
<p>The CORP pension reform includes three core elements, detailed below:</p>
<ol type="1">
<li>Improvements to ensure benefit sustainability for current employees and retirees,</li>
<li>A new defined contribution plan for corrections/detention officers hired after July 1, 2018, and</li>
<li>A new choice of retirement plans for probation/surveillance officers hired after July 1, 2018.</li>
</ol>
<p><strong><em>1. Improvements to Ensure Benefit Sustainability for Current Employees and Retirees</em></strong></p>
<p>For current employees and retirees, the reform will replace the uncertain and unsustainable PBI with a traditional, pre-funded cost of living adjustment (COLA) that provides certainty in retirement. This will serve the public interest by fixing the broken PBI mechanism that has been a major factor causing increased unfunded liabilities:</p>
<ul>
<li>The new COLA will be based on the changes in the consumer price index for the Phoenix region, with a cap of 2% maximum.</li>
<li>The new COLA will be pre-funded and actuarially accounted for in advance as part of normal cost determination, which has historically not been the case with the current PBI.</li>
<li>Replacing the PBI with a traditional COLA for current personnel and retirees will require a constitutional amendment subject to voter approval in the November 2018 election, similar to how the passage of Proposition 124 completed the PSPRS reform in 2016.</li>
</ul>
<p><strong><em>2. New Defined Contribution Plan for Corrections/Detention Officers Hired After 7/1/2018</em></strong></p>
<p>The reform creates an entirely new retirement plan design for all new correctional and detention officers entering CORP, which today account for approximately 90% of plan members. CORP employees hired on or after July 1, 2018 that are not sworn probation/surveillance officers will be offered a defined contribution (DC) retirement benefit:</p>
<ul>
<li>The employer will automatically contribute 5% of pay to the employees' DC plan.</li>
<li>The employee will contribute a default of 7% of pay to their own DC plan, with the individual option to reduce that contribution to a minimum of 5% of pay or increase it to the limit allowed by the IRS.</li>
<li>The DC plan vehicle will be the new optional 401(a) DC plan created in last year's PSPRS reform, which will be professionally managed and includes annuitization options, participant counseling and financial advice, restrictions against borrowing against 401(a) assets, and other guardrails designed to enhance retirement security.</li>
<li>A new DC disability &amp; death benefit plan will provide an equivalent benefit for new hires relative to members in the new defined benefit pension plan for probation and surveillance officers (described below).</li>
</ul>
<p><strong><em>3. New Plan Choice for Probation/Surveillance Officers Hired After 7/1/2018</em></strong></p>
<p>The reform will allow all new sworn probation officers or surveillance officers hired on or after July 1, 2018 the choice of entering the full corrections defined contribution plan described above, or a modified, lower-risk defined benefit plan. The new Tier 3 Probation defined benefit plan:</p>
<ul>
<li>Changes the pension benefit multiplier from a flat 2.5% to a graded multiplier that ranges from 1.25% to 2.25% depending on years of service.</li>
<li>Requires employees to pay 67% of normal cost and 50% of any potential future unfunded liabilities if the plan&rsquo;s experience does not meet actuarial assumptions.</li>
<li>Requires employers to pay 33% of normal cost and 50% of any potential future unfunded liabilities if the plan&rsquo;s experience does not meet actuarial assumptions.</li>
<li>Adopts a pensionable compensation cap of $70,000 (indexed every three years to the annualized growth in probation pay scales)</li>
<li>Uses a compounding COLA based on regional CPI with a 2.0% cap, unless the funded ratio of the plan falls below 90%.</li>
<li>Prevents COLAs from being issued in any year in which the funded ratio of the Tier 3 Probation defined benefit plan falls below 70%.</li>
<li>Increases the minimum benefit eligibility age from 52.5 years old to 55 years old (an actuarially equivalent benefit is available at age 52.5).</li>
</ul>
<p><strong>Effects of Reform: Fiscal</strong></p>
<p>In addition to improving retirement security and reducing financial risk, one of Sen. Lesko's policy priorities outlined at the beginning of the process was to keep the reform cost-neutral over the long-term. In the end, the CORP reform achieved this goal and is expected to yield short-term cost savings and long-term cost neutrality:</p>
<ul>
<li>The aggregate employer contribution rate and total pension liabilities are immediately reduced under the reform.</li>
<li>The PBI-to-COLA change is expected to result in an immediate improvement in CORP&rsquo;s funded ratio, according to estimates by the plan actuary.</li>
<li>In the long run, the reform is essentially cost neutral on a normal cost basis, according to actuarial modeling by both the plan's actuary and Reason Foundation.</li>
<li>By shifting most new CORP hires into a defined contribution plan, the reform will establish budget predictability for employers and employees while nearly eliminating all financial risk to taxpayers over time.</li>
</ul>
<p><strong>Effects of Reform: Risk Reduction</strong></p>
<p>The CORP reform will reduce risks over time by shifting the majority (approximately 90%) of new hires into a defined contribution plan, where, by definition, there is no possibility of new unfunded liabilities. The primary value of the reform from a solvency perspective is that it creates a long-term path to a scenario where CORP does not carry significant financial risks:</p>
<ul>
<li>The reform will reduce the growth in accrued liabilities (total pension promises) by 67% by 2047 and then eventually level-off.</li>
<li>The reform practically eliminates the taxpayer's exposure to future market risk and the potential for new unfunded liabilities to accrue for the next generation of workers.</li>
<li>All newly hired probation and surveillance officers after July 1, 2018 that choose the defined benefit pension plan will equally share investment risk with taxpayers under this reform, as any new unfunded liabilities are split between employers and employees on a 50/50 basis.</li>
</ul>
<p>It must be noted that the reform does not reduce the amount of pension benefits already promised&mdash;all of those still need to be paid and remain exposed to underfunding (unless the PSPRS/CORP board makes substantial changes to key actuarial assumptions). Nonetheless, with fewer liabilities exposed to underperforming asset risk, total unfunded liability payments will be less under the proposed reform in an underperforming scenario than under the baseline.</p>
<p><strong>Effects of Reform: Benefit Improvements</strong></p>
<p>Creating a defined contribution plan for most new hires helps current employees and retirees in the existing CORP pension plan by capping liabilities and improving the plan's solvency over time, as there would be fewer accrued liabilities exposed to the risk of underperforming assets or other overly optimistic actuarial assumptions.</p>
<p>The reform also creates a secure, portable benefit, allowing newly hired correctional/detention officers to move their pension benefits anywhere (unlike the current CORP pension plan). Further, the reform will offer a benefit better suited to the experience and demographics of the profession:</p>
<ul>
<li>Today, approximately 80% of correctional officers leave their job prior to the current 10-year pension vesting period, forfeiting the employer portion of their pension contributions.</li>
<li>Those employees only get back their own pension contributions, with some interest.</li>
<li>Under the reform, after three years correctional officers will get to keep 100% of both their own retirement contributions and their employer&rsquo;s contributions, improving retirement security for all employees.</li>
</ul>
<p>Last, the reform also creates more beneficiary choices for new employees, as retirement benefits under reform could be passed on to any beneficiary. By contrast, only spouses or minor children are entitled to a portion of the employee&rsquo;s pension today.</p>
<p><strong>Conclusion</strong></p>
<p>Like PSPRS in 2016, the CORP reform offers an excellent example of how state and local governments can approach meaningful pension reform. In both cases, stakeholders from across the spectrum convened and successfully forged a consensus agreement on what can often be a politically contentious issue. In CORP's case, the reform package gained bipartisan support in the legislature, plus the support of employee associations, employers, and taxpayer advocates.</p>
<p>The reform takes a multifaceted approach to tackling CORP's solvency problems. It will replace the broken permanent benefit increase mechanism undermining the plan with a traditional COLA tied to inflation. It will also offer new retirement plan designs for future CORP members that will provide better retirement security for employees while minimizing taxpayers' exposure to financial risk. Overall, the reform is designed to ensure that all CORP pension commitments are met, while putting into place a more financially sustainable retirement plan for the future.</p>
<p><strong>Additional Resources:</strong></p>
<ul>
<li>Reason Foundation presentation: <a href="/files/az_corp_reform_analysis_2017apr17_[final].pdf">Analysis of Arizona CORP Pension System &amp; Reform</a> (.pdf)</li>
<li>Full text and legislative history: <a href="https://apps.azleg.gov/BillStatus/BillOverview/69286">Senate Bill 1442</a> | <a href="https://apps.azleg.gov/BillStatus/BillOverview/69212">Senate Concurrent Resolution 1023</a></li>
<li>Reason Foundation <a href="http://reason.org/news/show/az-public-safety-pension-reform">analysis of 2016 PSPRS Reform</a></li>
<li>Arizona Auditor General, <a href="https://www.azauditor.gov/sites/default/files/15-111_Report.pdf"><em>Performance Audit and Sunset Review of the Public Safety Personnel Retirement System</em></a> (Report No. 15-111, September 2015)</li>
</ul>
<p><em>Leonard Gilroy and Anthony Randazzo are managing directors of the Pension Integrity Project at Reason Foundation. Pete Constant is senior fellow at the Pension Integrity Project and is the chief executive officer of the Retirement Security Initiative.</em></p>1014872@http://www.reason.orgMon, 17 Apr 2017 20:05:00 EDTleonard.gilroy@reason.org (Leonard Gilroy)A Proposal That Would Make Pension Crisis Even Worsehttp://www.reason.org/news/show/a-proposal-that-would-make-pension
Orange County Register <p>The California Public Employees&rsquo; Retirement System recently voted to cut benefits for nearly 200 retirees after the East San Gabriel Valley Human Services Consortium &mdash; which includes the cities of West Covina, Covina, Azusa and Glendora &mdash; failed to properly fund its pension plan for an agency known as LA Works.</p>
<p>It&rsquo;s just the latest example of the unfunded public pension crisis hitting parts of California.</p>
<p>CalPERS, the largest public pension fund in the country, also recently lowered its target investment rate of return, tacitly acknowledging that the state has been too aggressive with its expectations on investment returns. As a result, local governments will have to increase their own contributions &mdash; both to make up for the previous use of an excessive assumed rate of return and in anticipation of lower returns in the future.</p>
<p>Continuing to provide the same pension plans &ldquo;imposes greater costs on local and state government,&rdquo; Gov. Jerry Brown recently told Bloomberg. &ldquo;The pensions are squeezing local government more than state government.&rdquo;</p>
<p>Brown also predicted CalPERS will have to lower its expected investment return rates even further, causing the financial pressure to &ldquo;mount&rdquo; on cash-strapped local governments.</p>
<p>Nonetheless, a new report by the well-regarded Haas Institute at the University of California at Berkeley claims the public pension crisis is exaggerated.</p>
<p>The Haas report claims public pensions are only considered in trouble because of unnecessary accounting standards about how to report degrees of risk. If only states like California were to adopt Social Security-style, pay-as-you-go approaches to funding benefits, the logic goes, then there would be no perception of crisis.</p>
<p>This proposal runs counter to how public pension plans are supposed to operate. The accounting rules governing pension systems like CalPERS require &ldquo;prefunding&rdquo; &mdash; setting aside a specific amount of money each year to be combined with investment returns so that on the day a worker retires, there is enough available to provide the promised retirement benefits.</p>
<p>Pre-funding pensions aims to avoid asking future taxpayers to cover the retirement costs for today&rsquo;s workers, since future generations do not directly benefit from the public services delivered by current workers.</p>
<p>By contrast, shifting to a &ldquo;PAYGO&rdquo; model would enshrine an intergenerational equity problem. Politicians today would negotiate pay rates and benefits for today&rsquo;s public sector employees, but lean on voiceless future employees and taxpayers to pay for most of the costs.</p>
<p>This kind of solution &mdash; reduce payments today and increase them tomorrow &mdash; is exactly the kind of thinking that got CalPERS and many other public pension plans into trouble in the first place.</p>
<p>There is nothing inherently wrong with providing retirement income via a defined-benefit pension plan. But, if state and local governments are going to provide pensions, they must properly prefund those benefits. The proliferation of unfunded pension liabilities has largely been caused by state and local pension boards failing to adequately predict the future, along with being too slow to increase contribution rates as necessary.</p>
<p>Unfortunately, when a pension plan&rsquo;s investment assumptions about the future are wrong, it will come up short on the money necessary to pay benefits &mdash; with taxpayers on the hook for covering those shortfalls. CalPERS is slowly recognizing that its past assumptions have been too optimistic, which is a primary source of the pension debt driving up local government contribution rates.</p>
<p>When CalPERS announced it was reducing the pensions of the almost 200 former LA Works employees, its statement said, &ldquo;The board was forced to make this painful decision after East San Gabriel Valley failed to stand by its contractual obligations despite repeated and numerous attempts by CalPERS to avoid this terrible situation.&rdquo;</p>
<p>Abandoning the prefunding of pensions would ultimately result in many more &ldquo;painful&rdquo; and &ldquo;terrible&rdquo; situations that end with retirees not receiving the benefits they were promised.</p>
<p>Relying on future politicians to prioritize paying for pension benefits out of general fund revenue instead of using that money for public safety, education, or transportation projects is a recipe for a new kind of retirement disaster.</p>
<p><em><a href="http://www.ocregister.com/2017/04/06/a-proposal-that-would-make-pension-crisis-even-worse/">This column first appeared in the Orange County Register.</a></em></p>1014958@http://www.reason.orgThu, 06 Apr 2017 07:00:00 EDTleonard.gilroy@reason.org (Leonard Gilroy)Pension Reform Newsletter - March 2017http://www.reason.org/news/show/pension-reform-newsletter-mar17
<p>This newsletter from Reason Foundation's Pension Integrity Project highlights articles, research, opinion, and other information related to public pension challenges and reform efforts across the nation. You can find previous editions <a href="http://reason.org/newsletters/pensionreform/">here</a>.</p>
<p><strong><span style="font-size: 120%;">In This Issue:</span></strong></p>
<p><strong><a href="#a">Articles, Research &amp; Spotlights</a></strong></p>
<ul type="disc">
<li><a href="#b">Beware the Trump Bump</a></li>
<li><a href="#c">New Report Examines Target Date Funds</a></li>
<li><a href="#d">Concerns Over Hedge Fund Hobgoblins Based on Misinformation</a></li>
<li><a href="#e">Considering Proposed Paths Forward in the Dallas Pension Crisis</a></li>
</ul>
<p><strong><a href="#i">News Notes</a></strong></p>
<p><strong><a href="#j">Quotable Quotes on Pension Reform</a></strong></p>
<p><strong><a href="#k">Contact the Pension Reform Help Desk</a></strong></p>
<hr />
<p><a name="a"></a><strong><span style="font-size: 120%;">Articles, Research &amp; Spotlights</span></strong></p>
<p><a name="b"></a><br /><strong>Beware the Trump Bump</strong></p>
<p>Higher investment returns in the wake of the November 2016 election are welcome news for pension systems around the country. While the average assumed rate of return for public pension plans (around 7.5%) is likely still too high, greater investment returns would provide troubled pension systems with much-needed breathing room. But this relief can only happen if the "Trump Bump" is here to stay. As Reason's Daniel Takash writes, pension systems should prepare for this bump to turn out to be a "sugar high" that will subside or worse: a bubble that will burst if Trump's economic policies fail to produce the promised gains.<br /><span style="font-size: 80%; color: red;">&raquo; <a href="http://reason.org/news/show/beware-the-trump-bump">FULL ARTICLE</a></span></p>
<p><span style="font-size: 80%;">&raquo; <a href="#top">return to top</a></span></p>
<hr />
<p><a name="c"></a><br /><strong>New Report Examines Target Date Funds</strong></p>
<p>Individual investors and retirement fund managers alike are looking for best ways to balance the competing goals of portfolio diversification, de-risking of asset allocations, and securing retirement income. To that end, target date funds (TDFs) have become an increasingly popular way to provide a low-maintenance, self-adjusting investment option that automatically rebalances and de-risks the investment portfolio over time as an investor moves closer to retirement. According to a recent report by Boston College's Center for Retirement Research, TDFs often invest in specialized assets, charge modest fees, and earn returns that are broadly in line with other mutual funds.<br /><span style="font-size: 80%; color: red;">&raquo; <a href="http://reason.org/blog/show/target-date-funds-report">FULL ARTICLE</a></span></p>
<p><span style="font-size: 80%;">&raquo; <a href="#top">return to top</a></span></p>
<hr />
<p><a name="d"></a><br /><strong>Concerns Over Hedge Fund Hobgoblins Are Based on Misinformation</strong></p>
<p>Those on both sides of the pension reform movement are rightfully concerned over pension systems' experiences with hedge funds and other alternative investments. Some of these concerns are legitimate, as hedge fund investments tend to come with high management fees that can only be justified with outstanding performance. Others are based on more general, populist mistrust of financial institutions. Asset allocation decisions for pension plans are a serious issue, but Reason's Daniel Takash writes that opponents of hedge fund investments can do themselves a disservice when they make sweeping claims divorced from the primary cause for the rise of hedge fund investments by pension systems&mdash;the need to find ways of hitting increasingly unrealistic assumed rate of return targets.<br /><span style="font-size: 80%; color: red;">&raquo; <a href="http://reason.org/blog/show/concerns-over-hedge-fund-hobgoblins">FULL ARTICLE</a></span></p>
<p><span style="font-size: 80%;">&raquo; <a href="#top">return to top</a></span></p>
<hr />
<p><a name="e"></a><br /><strong>Considering Proposed Paths Forward in the Dallas Pension Crisis</strong></p>
<p>As the Texas 2017 legislative session unfolds, conflict and controversy continue to haunt the Dallas Police and Fire Pension System (DPFP). The severely underfunded system requires a significant infusion of contributions at minimum, as well as dismantling its solvency-destroying Deferred Retirement Option Plan program that fell victim to more than $500 million in lump-sum withdrawals last year amid pensioners' fears of the looming insolvency of the system. Despite a lingering stalemate among policymakers over the appropriate course of action, Reason's Anil Niraula writes that recent developments suggest that the parties may finally be finding some common ground on the potential reform path forward.<br /><span style="font-size: 80%; color: red;">&raquo; <a href="http://reason.org/blog/show/a-path-forward-for-dpfp">FULL ARTICLE</a></span></p>
<p><span style="font-size: 80%;">&raquo; <a href="#top">return to top</a></span></p>
<hr />
<p><a name="i"></a><strong><span style="font-size: 120%;">News Notes</span></strong></p>
<p><br /><strong>New CRS Report on Participation in Employer-Sponsored Pensions</strong>: A Congressional Research Service report released last month examines key differences in retirement plan participation among different kinds of employees. Among the findings, the CRS reports that 85% all state and local government workers have access to a defined benefit pension plan, with 75% participating in the plan. By contrast, only 18% of private sector workers have access to a defined benefit pension plan, with 15% participating. The full report is <a href="https://fas.org/sgp/crs/misc/R43439.pdf">available here</a>.</p>
<p><strong>New National League of Cities Pension Survey</strong>: Earlier this month, the National League of Cities (NLC) released the results of a survey finding that, between 2009 and 2016, 74% of cities implemented reforms designed to address their unfunded pension liabilities. The most common reform was to increase employee contribution rates (33%), followed by plan design changes (22%), reduced benefits (17%) and reduced cost-of-living adjustments (12%). The full report is <a href="http://nlc.org/resource/making-informed-changes-to-public-sector-pension-plans">here</a>.</p>
<p><strong>CalPERS Issues Pension Spiking Regulations</strong>: Earlier this month, the California Public Employees' Retirement System (CalPERS) Board of Administration approved new draft regulations governing pensionable compensation in accordance with the 2012 Public Employees' Pension Reform Act (PEPRA). The draft regulations eliminate six types of compensation, including bonus pay, management incentive pay, and uniform allowances. "These regulations ensure compliance with pension reform and provide consistency and guidance on anti-pension spiking laws governing pensionable compensation," said Rob Feckner, president of the CalPERS Board. "Without the regulations the risk of employers inconsistently interpreting the law is high." More information is <a href="https://www.calpers.ca.gov/page/newsroom/calpers-news/2017/new-regulations-against-pension-spiking">available here</a>.</p>
<p><strong>Iowa PERS Lowers Investment Return Assumption</strong>: Last week, the investment board of the Iowa Public Employees' Retirement System (IPERS) approved lowering the plan's assumed rate of return for investments from 7.5% to 7.0%, while also lowering assumptions related to inflation, payroll growth, wage growth, and interest on member accounts in the wake of an accelerated experience study. More information is available <a href="http://www.desmoinesregister.com/story/news/politics/2017/03/24/ipers-cuts-key-target-unfunded-pension-liabilities-up-13-billion/99600866/">here</a> and <a href="http://www.ai-cio.com/channel/NEWSMAKERS/Iowa-Public-Pension-Lowers-Economic-Assumptions/">here</a>.</p>
<p><span style="font-size: 80%;">&raquo; <a href="#top">return to top</a></span></p>
<hr />
<p><a name="j"></a><strong><span style="font-size: 120%;">Quotable Quotes on Pension Reform</span></strong></p>
<p><br />"The City's annual pension contribution has grown by over 230 percent since fiscal year 2001. [&hellip;] These increasing pension costs have caused us to cut important public services while the pension fund's health has grown weaker. In fact, our pension fund has actually dropped from 77 percent funded to less than 50 percent funded during the same time our contributions were so rapidly increasing."<br /><br />&mdash;Philadelphia Mayor Jim Kenney, quoted in Jim Saksa, "<a href="http://planphilly.com/articles/2017/03/02/putting-philadelphia-s-149-million-pension-fund-loss-into-context">Putting Philadelphia's $149 million pension fund loss into context</a>," PlanPhilly.com, March 2, 2017.</p>
<p><br />"Phoenix recently released its five-year budget forecast, an estimate of future operating revenues and expenses, that shows pension costs will remain an albatross on the city's financial health. [&hellip;] Recurring deficit forecasts come as the city's pension costs have increased more than 208 percent in the last decade. Its general-fund pension bill was about $95.3 million for the 2007-08 fiscal year, compared with $294 million next year."<br /><br />&mdash;Dustin Gardiner, "<a href="http://www.azcentral.com/story/news/local/phoenix/2017/02/28/pension-costs-still-crippling-phoenix-budget/98179552/">Soaring pension costs still crippling Phoenix budget</a>," <em>Arizona Republic</em>, February 28, 2017.</p>
<p><br />"Notice how CalPERS is choosing to value liabilities at the same rate as it expects to earn on assets. That's like you owing $100,000 on a mortgage but because you think you're going to earn twice as much as the mortgage interest rate from investing your cash in the stock market, you report your mortgage at only $50,000. That's neither true&#8202;&mdash;&#8202;you owe the mortgage obligation regardless of how well or poorly you invest your other assets&#8202;&mdash;&#8202;nor sustainable."<br /><br />&mdash;David Crane, &ldquo;<a href="https://medium.com/&#64;DavidGCrane/its-the-lie-that-gets-you-d83723238c76#.9f5iuz5fp">It's The Lie That Gets You: How Funded Ratios can decline even when stock markets rise</a>,&rdquo; Medium.com (blog), March 5, 2017.</p>
<p><br />"Unless the system is fixed now it will collapse. The course that we're on suggests strongly without a doubt, the system will get to a point where the public pension funds simply will not have the money to meet the promises they made."<br /><br />&mdash;Stanford University Professor Joe Nation, quoted in Arlene Martinez, &ldquo;<a href="http://www.vcstar.com/story/news/local/2017/03/09/pension-costs-soar-ventura-county-cities/98606436/">Pension costs soar for Ventura County cities</a>,&rdquo; <em>Ventura County Star</em>, March 9, 2017.</p>
<p><br />"I do think there will be another conversation in the not too distant future about what is affordable for [San Francisco] and our employees for pensions [&hellip;] I don't think where we are is where we need to end up."<br /><br />&mdash;San Francisco Controller Ben Rosenfield, quoted in Romy Varghese, "<a href="https://www.bloomberg.com/news/articles/2017-03-20/even-san-francisco-flush-with-tech-wealth-has-pension-problems">Even San Francisco, Flush With Tech Wealth, Has Pension Problems</a>," Bloomberg.com, March 20, 2017.</p>
<p><span style="font-size: 80%;">&raquo; <a href="#top">return to top</a></span></p>
<hr />
<p><a name="k"></a><strong><span style="font-size: 120%;">Contact the Pension Reform Help Desk</span></strong></p>
<p>Reason Foundation's Pension Reform Help Desk provides information and technical resources for those wishing to pursue pension reform in their states, counties and cities. Feel free to contact the Reason Pension Reform Help Desk by e-mail at <a href="mailto:pensionhelpdesk&#64;reason.org">pensionhelpdesk&#64;reason.org</a>.</p>
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<p><em>Follow the discussion on pensions and other governmental reforms at <a href="http://www.reason.org">Reason Foundation's website</a> or on Twitter (<a href="https://twitter.com/ReasonReform?lang=en">&#64;ReasonReform</a>). As we continually strive to improve the publication, please feel free to send your questions, comments and suggestions to <a href="mailto:leonard.gilroy&#64;reason.org">leonard.gilroy&#64;reason.org</a>.</em></p>
<p>Leonard Gilroy<br />Senior Managing Director, Pension Integrity Project<br />Reason Foundation<br /><br />Anthony Randazzo<br />Managing Director, Pension Integrity Project<br />Reason Foundation</p>1014859@http://www.reason.orgFri, 31 Mar 2017 14:00:00 EDTleonard.gilroy@reason.org (Leonard Gilroy)Pension Reform Newsletter - February 2017http://www.reason.org/news/show/pension-reform-newsletter-feb17
<p>This newsletter from Reason Foundation's Pension Integrity Project highlights articles, research, opinion, and other information related to public pension challenges and reform efforts across the nation. You can find previous editions <a href="http://reason.org/newsletters/pensionreform/">here</a>.</p>
<p><strong><span style="font-size: 120%;">In This Issue:</span></strong></p>
<p><strong><a href="#a">Articles, Research &amp; Spotlights</a></strong></p>
<ul type="disc">
<li><a href="#b">Pension Funds and Investment Risk</a></li>
<li><a href="#c">Optional Defined Contribution Plan Proposed for Maryland State Employees</a></li>
<li><a href="#d">More Evidence for the "New Normal" for Investment Returns</a></li>
<li><a href="#e">Changes to Pension Plans Since the Financial Crisis</a></li>
<li><a href="#f">Cognitive Aging and Managing Retiree Finances</a></li>
</ul>
<p><strong><a href="#i">News Notes</a></strong></p>
<p><strong><a href="#j">Quotable Quotes on Pension Reform</a></strong></p>
<p><strong><a href="#k">Contact the Pension Reform Help Desk</a></strong></p>
<hr />
<p><a name="a"></a><strong><span style="font-size: 120%;">Articles, Research &amp; Spotlights</span></strong></p>
<p><a name="b"></a><br /><strong>How Much Investment Risk Should Pension Funds Take?</strong></p>
<p>Over the past several decades, public pension funds have substantially changed their risk profiles, going from mostly-bonds portfolios in the 1980s to investing the bulk of their money in equities and alternative assets today. How did this happen, and how much risk-taking is appropriate for those pension funds? Reason's Truong Bui writes that recent research by the Rockefeller Institute of Government provides valuable answers to such questions.<br /><span style="font-size: 80%; color: red;">&raquo; <a href="http://reason.org/blog/show/how-much-investment-risk-should-pen">FULL ARTICLE</a></span></p>
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<p><a name="c"></a><br /><strong>Maryland Gov. Larry Hogan Proposes Optional Defined Contribution Plan for State Employees</strong></p>
<p>A new proposal by Maryland Gov. Larry Hogan would give new state employees the option to forgo a defined benefit pension entirely in favor of a defined contribution plan. While this proposal alone is almost certainly insufficient to solve the funding crisis facing the state's $45 billion retirement system, Reason's Daniel Takash writes that it would definitely be a step in the right direction, and is one piece of what could be a complete pension reform package if bundled with meaningful funding policy changes.<br /><span style="font-size: 80%; color: red;">&raquo; <a href="http://reason.org/blog/show/larry-hogan-defined-contribution">FULL ARTICLE</a></span></p>
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<p><a name="d"></a><br /><strong>More Evidence for the Public Pension "New Normal" for Investment Returns</strong></p>
<p>The "new normal" of a lower-yield investment environment for state and local pension funds is quickly becoming an established fact. A new report from J.P. Morgan Asset Management Company suggests that this lower performing investment trend is likely to continue, with low returns for most asset classes within the next 10 to 15 years, and marginally higher fluctuations in annual yields, all relative to what plans used to get 10 to 15 years ago. According to Reason's Anil Niraula and Anthony Randazzo, this offers yet more evidence justifying continued efforts by public pension funds to adjust their long-term return assumptions, and 'de-risk' investment portfolios.<br /><span style="font-size: 80%; color: red;">&raquo; <a href="http://reason.org/blog/show/more-evidence-lower-market-returns">FULL ARTICLE</a></span></p>
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<p><a name="e"></a><br /><strong>Changes to Pension Plans Since the Financial Crisis</strong></p>
<p>Market losses since the financial crisis, unrealistic actuarial assumptions, and an aging workforce are reshaping the way public pension plans approach the funding of increasingly costly retirement benefits. What have state and local governments been doing about it? Reason's Anil Niraula writes that the answer is a lot of little things, but very few substantive reforms, according to data collected by the Center for Retirement Research at Boston College.<br /><span style="font-size: 80%; color: red;">&raquo; <a href="http://reason.org/blog/show/recent-pension-plan-change-patterns">FULL ARTICLE</a></span></p>
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<p><a name="f"></a><br /><strong>The Retirees Are Alright: Report Finds Elderly Are Mostly Capable of Managing Finances</strong></p>
<p>As we age, there is generally a decline in fluid intelligence (general reasoning capacities used to solve new problems), but an increase in crystallized intelligence (the ability to call upon knowledge and experience to solve problems). This process, called "cognitive aging," and its effect on the ability of retirees to manage their savings is the subject of a new report published by the Boston College Center for Retirement Research (CRR). In a new article, Reason's Daniel Takash writes that the report's findings suggest that grandma and grandpa are, on balance, more than capable of managing their retirement&mdash;a finding with important implications for debates related to public sector pension reform.<br /><span style="font-size: 80%; color: red;">&raquo; <a href="http://reason.org/blog/show/the-retirees-are-alright-report-fin">FULL ARTICLE</a></span></p>
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<p><a name="i"></a><strong><span style="font-size: 120%;">News Notes</span></strong></p>
<p><strong>CalPERS' Lower-Risk Asset Allocation Expected to Return 5.8%</strong>: In December, CalPERS's board established a policy to lower its assumed rate of return to 7.0% by 2020. But according to a recent Reuters article, the board established a new, lower-risk asset allocation around the same time that is expected to return 5.8% over the next decade. The full article is <a href="http://www.reuters.com/article/california-calpers-rates-idUSL1N1FS04D">here</a>.</p>
<p><strong>Moody's Cites Rising Budget Pressures from Lowered Pension Return Assumptions</strong>: A new report from Moody's Investors Service finds that state and local budget pressures are accelerating in the wake of moves by many public pension systems to lower their assumed rates of return to reflect lower investment return expectations. According to the press release, "[t]he rising cost dynamic highlights the importance of future revenue growth in analysis of state and local government credit stability." More information is <a href="https://www.moodys.com/research/Moodys-Lower-investment-expectations-are-accelerating-state-and-local-government--PR_362212?WT.mc_id=AM~V1JEU19TQl9SYXRpbmcgTmV3c19BbGxfRW5n~20170217_PR_362212">available here</a>.</p>
<p><strong>New Report Examines Teacher Pension Inequities</strong>: In a report issued late last month by the Fordham Institute, EdChoice Fiscal Policy Director Martin Lueken identified the "crossover point" for each state's largest school district (and D.C.), which is the point in time at which a new teacher needs to remain in the same pension system for their level of retirement benefits to exceed the value of their contributions. Lueken finds that the median crossover point of the 51 districts is 25 years, and in 35 districts, nearly 75% of teachers will leave the profession before they reach the crossover point. The full report is <a href="https://edexcellence.net/publications/no-money-in-the-bank">available here</a>.</p>
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<p><a name="j"></a><strong><span style="font-size: 120%;">Quotable Quotes on Pension Reform</span></strong></p>
<p>"Clearly, this nation's pension imbroglio can no longer be relegated to the back burner. Well, perhaps not so clearly. But it certainly shouldn't be: unfunded liabilities are a disaster in the making that lurk behind a gray wall of numbers, graphs and pie charts. As Flint and Detroit found out, expecting the problem to recede with an uptick in the stock market or the imposition of a new tax or the wave of a consultant's wand is simply delusional."<br /><br />&mdash;Thomas Healey, "<a href="http://www.milkenreview.org/articles/in-the-trenches-with-pension-reform?IssueID=18">In the Trenches with Pension Reform</a>," <em>Milken Institute Review</em>, January 17, 2017.</p>
<p><br />"Discount rates and pension contributions are inextricably linked. Cutting the rate increases pension contribution costs&mdash;that's how the math works. And that's why the decision to reduce it is so difficult and why it was made only after carefully reviewing and thoroughly analyzing the current economic climate. You can't have it both ways. You can't beat the drums for a rate reduction and then unleash an onslaught of criticism and complaints when we do."<br /><br />&mdash;CalPERS board member Richard Costigan, "<a href="http://www.sacbee.com/opinion/op-ed/soapbox/article132957504.html">Criticism of CalPERS is often misplaced</a>," <em>Sacramento Bee</em>, February 15, 2017.</p>
<p><br />"I just worry that if we don't fix our roof, we're going to create damage to the structure of our state. Maybe it's through bond ratings and maybe it's through children that aren&rsquo;t properly educated."<br /><br />&mdash;Katie Durant, former chair of the Oregon Investment Council, quoted in Jeff Mapes, "<a href="http://www.opb.org/news/article/oregon-pers-pension-system-cost-increases/">Huge Bill Is Coming Due For Oregon's Past Pension System Mistakes</a>," Oregon Public Broadcasting, February 2, 2017.</p>
<p><br />"When the county hires senior managers externally, many are mid- or late-career professionals. A 'thirty-years-and-a-gold watch' retirement benefit is rarely compelling to a person with less than 10 or 15 years left to work.<br /><br />In our recent recruiting experience, Millennials also are not terribly enthusiastic about a benefit that takes 30 years to fully realize. This is crucial because a retirement plan isn't simply a way to enrich public employees; it is a tool for recruiting and retaining a quality workforce."<br /><br />&mdash;Caroline County, MD Administrator Ken Decker, "<a href="http://marylandreporter.com/2017/02/21/maryland-should-look-to-local-government-for-pension-solutions/">Maryland should look to local government for pension solutions</a>," MarylandReporter.com, February 21, 2017.</p>
<p><br />"Payroll growth was negative and you assumed 4 percent (growth)? Were any of you paying attention?"<br /><br />&mdash;Kentucky Retirement Systems Board Chairman John Farris, quoted in, John Cheves, "<a href="http://www.kentucky.com/news/politics-government/article133142369.html">Troubled Kentucky pension system might need billions more than assumed</a>," <em>Lexington Herald-Leader</em>, February 17, 2017.</p>
<p><br />"That's not a pension system. That's a checking account, and it's about to go bankrupt."<br /><br />&mdash;Kentucky Gov. Matt Bevin in his 2017 State of the Commonwealth address, quoted in, John Cheves, "<a href="http://www.kentucky.com/news/politics-government/article133142369.html">Troubled Kentucky pension system might need billions more than assumed</a>," <em>Lexington Herald-Leader</em>, February 17, 2017.</p>
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<hr />
<p><a name="k"></a><strong><span style="font-size: 120%;">Contact the Pension Reform Help Desk</span></strong></p>
<p>Reason Foundation's Pension Reform Help Desk provides information and technical resources for those wishing to pursue pension reform in their states, counties and cities. Feel free to contact the Reason Pension Reform Help Desk by e-mail at <a href="mailto:pensionhelpdesk&#64;reason.org">pensionhelpdesk&#64;reason.org</a>.</p>
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<hr />
<p><em>Follow the discussion on pensions and other governmental reforms at <a href="http://www.reason.org">Reason Foundation's website</a> or on Twitter (<a href="https://twitter.com/ReasonReform?lang=en">&#64;ReasonReform</a>). As we continually strive to improve the publication, please feel free to send your questions, comments and suggestions to <a href="mailto:leonard.gilroy&#64;reason.org">leonard.gilroy&#64;reason.org</a>.</em></p>
<p>Leonard Gilroy<br />Senior Managing Director, Pension Integrity Project<br />Reason Foundation<br /><br />Anthony Randazzo<br />Managing Director, Pension Integrity Project<br />Reason Foundation</p>1014819@http://www.reason.orgFri, 24 Feb 2017 13:29:00 ESTleonard.gilroy@reason.org (Leonard Gilroy)Michigan Pension Reform Analysishttp://www.reason.org/news/show/mpsers-pension-analysis
<p>Over the past two decades, the Michigan Public School Employees' Retirement System (MPSERS) has experienced volatile changes in its funded level. Between 1997 and 2016, unfunded liabilities increased by $29 billion, and the funded ratio decreased from 100% to 59.7%.&nbsp;</p>
<p>We have developed a detailed analysis of how Michigan got to this place, as well as analysis of recently proposed legislation to address the structurally&nbsp;unsound design of MPSERS.&nbsp;</p>
<p><a href="http://reason.org/files/mpsers_reform_analysis_-_testimony_full_06142017.pdf">Click here</a>&nbsp;for our full presentation on the scope of the MPSERS debt, forecasts of growing costs if nothing is done, and breakdown of how proposed changes would improve the status quo.&nbsp;</p>
<p>&nbsp;</p>
<p>Learn more about MPSERS pension reform &mdash;&nbsp;</p>
<ul>
<li><strong>Explainer 1:</strong>&nbsp;<a href="http://reason.org:8080/files/onepager_mpsers_01_theproblems_sourced.pdf">Why Michigan Needs Pension Reform</a></li>
<li><strong>Explainer 2:</strong>&nbsp;<a href="http://reason.org/files/onepager_mpsers_02_mythsnewhires-frontbackversion.pdf">Why New Hires Are Not Necessary to Fund the MPSERS Pension Plan</a></li>
<li><strong>Explainer 3</strong>:&nbsp;<a href="http://reason.org:8080/files/onepager_mpsers_03_assumedreturneffects_sourced.pdf">Why the Hybrid Plan is Risky: There is&nbsp;Less Than a 50% Chance of Successfully Earning a 7% Return</a></li>
<li><strong>Explainer 4</strong>:&nbsp;<a href="http://reason.org/files/onepager_mpsers_04_retention_sourced.pdf">Only One-Third of Teachers Get a Full Pension</a></li>
<li><strong>Explainer 5:&nbsp;</strong><a href="http://reason.org/files/onepager_mpsers_05_hybrid81.pdf">Contributions to the Current Hybrid Plan are Only Half of What is Necessary</a>&nbsp;</li>
<li><strong><a href="http://reason.org:8080/files/pensionintegrityproject_about.pdf">What is the Pension Integrity Project</a></strong></li>
</ul>
<p>&nbsp;</p>
<p><span style="text-decoration: underline;">Summary Information<br /></span></p>
<p><strong>1. Underperforming Investment Returns</strong></p>
<p>Our analysis finds that underperforming investment returns have been a key driver of this problem of degrading solvency. MPSERS has long assumed an 8% rate of return, but has average returns much lower than this in recent years. Average returns over 30-years and 40-years aren't far off this&nbsp;8% target, but these averages are relatively meaningless for understanding future performance because markets today are structurally different than several decades ago.</p>
<p>Average investment returns over the past 20-years (7.2%) and 15-years (6.5%) are more reflective of the trends of the future. Forecasts of future investment returns suggest that there is less than a 50% chance Michigan will earn even a 7% investment return average over the coming decades &mdash; a risk&nbsp;sitting squarely on the shoulders of Michigan taxpayers.</p>
<p><strong>2. The Hybrid Plan Did Not Fully Fix the Problem</strong></p>
<p>In 2010, Michigan created a hybrid-style plan for new hires called the Pension Plus Plan, which uses a 7% assumed rate of return. Some have argued that this fixes the problem, but in fact even a 7% assumption is too high.&nbsp;Plus, there are other aggressive actuarial assumptions used by MPSERS that have contributed to the funding problems. The Pension Plus Plan is exposed to the same patterns and practices threatening the Non-Hybrid plan.</p>
<p>Many market forecasts suggest average returns for pension plans like MPSERS are likely to be around 6% (or less) in the coming decades.</p>
<p>Depending on the forecast, the 7% return assumption used by the Pension Plus hybrid plan has between a 45% and 25%&nbsp;chance of being accurate. The hybrid plan is thus exposing taxpayers to underperforming investment returns.&nbsp;</p>
<p><strong>3. Doing Nothing Will Mean Growing Pension Costs for Schools</strong></p>
<p>If Michigan continues to ignore the problems with MPSERS, then pension costs are likely to more than double over the next two decades. Specifically, the actuarially determined contribution for the state and school districts will likely spike from around 30% of teacher payroll to around 60% of teacher payroll. (See <a href="/files/pensions/MPSERS/MPSERS_NeedForChange.pdf">figure here</a>.)</p>
<p>The growing costs to fund pension benefits are only going to continue crowding out the school aid fund, education resources, and the ability to increase teacher compensation.</p>
<p><strong>4. Pensions Are Hurting the State&rsquo;s Bond Rating</strong></p>
<p>Surging pension liabilities for the state budget are an &ldquo;uncertainty&rdquo; that is keeping Michigan&rsquo;s bond rating from improving, according to Moody&rsquo;s Investor Service.</p>
<p><strong>5. Learning from the History of Michigan State Employee Pension Plan</strong></p>
<p>In 1996, Michigan became the first state to adopt a defined contribution only plan for state employees. There have been a number of benefits to this forward thinking policy change, but also a number of failures. In August 2016, we&nbsp;<a href="http://reason.org/news/show/pension-reform-case-study-michigan">updated a case study</a> of the pension reform for the Michigan State Employees Retirement System (MSERS) and we discuss how Michigan could have managed the reform process better. The lessons of MSERS are relevant to ensuring MPSERS reform is done correctly.</p>1014789@http://www.reason.orgFri, 03 Feb 2017 00:00:00 ESTanthony.randazzo@reason.org (Anthony Randazzo)Pension Reform Newsletter - January 2017http://www.reason.org/news/show/pension-reform-newsletter-jan17
<p>This newsletter from Reason Foundation's Pension Integrity Project highlights articles, research, opinion, and other information related to public pension challenges and reform efforts across the nation. You can find previous editions <a href="http://reason.org/newsletters/pensionreform/">here</a>.</p>
<p><strong><span style="font-size: 120%;">In This Issue:</span></strong></p>
<p><strong><a href="#a">Articles, Research &amp; Spotlights</a></strong></p>
<ul type="disc">
<li><a href="#b">How CalPERS' Lowered Investment Return Assumption Impacts Taxpayers</a></li>
<li><a href="#c">Court Upholds California's Ban on Airtime Purchases</a></li>
<li><a href="#d">New Reports Examine Omaha, Lincoln Pension Liabilities and Risks</a></li>
<li><a href="#e">Simulation Models Illuminate Risks Faced by Public Pension Plans</a></li>
<li><a href="#f">The Role of Governance in the Dallas Police and Fire Pension Crisis</a></li>
</ul>
<p><strong><a href="#j">Quotable Quotes on Pension Reform</a></strong></p>
<p><strong><a href="#k">Contact the Pension Reform Help Desk</a></strong></p>
<hr />
<p><a name="a"></a><strong><span style="font-size: 120%;">Articles, Research &amp; Spotlights</span></strong></p>
<p><a name="b"></a><br /><strong>How CalPERS' Lowered Investment Return Assumption Impacts Taxpayers</strong></p>
<p>The board of the California Public Employees Retirement System (CalPERS) sent shockwaves through the Golden State last month when it approved lowering its investment returns assumption from 7.5% to 7.0% over the coming years, a move that revealed the pension plan is billions more in debt than was previously recognized. In the short term, this change is going to mean increased pension contributions for the state and most local governments, which could potentially impact taxpayers through service cuts or tax increases. But as Reason's Leonard Gilroy writes in a recent <em>Orange County Register</em> column, there is a silver lining for taxpayers in the long term.<br /><span style="font-size: 80%; color: red;">&raquo; <a href="http://reason.org/news/show/calpers-pension-lower-return">FULL ARTICLE</a></span></p>
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<hr />
<p><a name="c"></a><br /><strong>Public Workers Can Get Pensions Only for Time They Actually Worked, Court Rules</strong></p>
<p>A California appellate court upheld the provisions of a state pension reform law enacted in 2011 that eliminated so-called "airtime purchases," where public workers were able to boost their pensions by purchasing an additional five years of service time without having to actually work for those years. Taken together with a separate ruling last year upholding Marin County's elimination of pension spiking, Reason.com reporter Eric Boehm writes that the new ruling can be seen as part of a developing trend of courts taking a skeptical look at the so-called "California Rule."<br /><span style="font-size: 80%; color: red;">&raquo; <a href="http://reason.com/blog/2017/01/18/public-workers-can-only-get-pensions-for">FULL ARTICLE</a></span></p>
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<hr />
<p><a name="d"></a><br /><strong>New Reports Examine Omaha, Lincoln Pension Liabilities and Risks</strong></p>
<p>Nebraska's municipalities are somewhat of an outlier nationally as most cities and counties across the state offer either a cash balance plan or defined contribution plan to public sector workers. Two striking exceptions to this are the cities of Omaha and Lincoln, each of which offers defined benefit retirement plans for public safety workers. Omaha runs a defined benefit plan for its civilian employees too (though new hires for the next few years are being offered a cash balance plan as a part of a collective bargaining agreement).<br /><br />Unfortunately, Omaha and Lincoln are not exceptions when it comes to the accumulation of unfunded pension liabilities. Combined, the two cities report about $920 million in unfunded liabilities&mdash;but, using more realistic assumptions, they are likely facing around $2.2 billion in pension debt. This is one of the findings from two policy studies that Reason co-published this month with the Nebraska-based Platte Institute. Using actuarial analysis, the Lincoln report also shows that unfunded liabilities in the city's public safety pension fund are likely to quadruple over the next 20 years if there are no changes to plan assumptions and recent patterns persist. The Omaha report also includes a forecast that shows within the next two decades the city will probably be paying more than 50 cents for every dollar in salary to cover increasing unfunded liability amortization payments.<br /><span style="font-size: 80%; color: red;">&raquo; <a href="http://reason.org/news/show/omaha-pension-debt-problem-2"><strong>STUDY</strong>: Pension Debt: The Billion Dollar Problem Still Threatening Omaha</a></span><br /><span style="font-size: 80%; color: red;">&raquo; <a href="http://reason.org/news/show/lincoln-pension-debt-problem"><strong>STUDY</strong>: Pension Debt: The Still Unsolved Problem Threatening Lincoln</a></span></p>
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<hr />
<p><a name="e"></a><br /><strong>Simulation Models Illuminate Risks Faced by Public Pension Plans</strong></p>
<p>Last year, the Rockefeller Institute of Government released a paper showing how underfunding risks are significantly increased through funding practices commonly employed by public pension plans, such as high discount rates and long open amortization periods. Rockefeller is back with a new report that, according to Reason's Truong Bui, helps answer how investment risks translate to volatility in funded ratios and contribution rates, and how specific assumed return rates and investment practices are related to this process of investment risk and volatility.<br /><span style="font-size: 80%; color: red;">&raquo; <a href="http://reason.org/news/show/simulation-models-illuminate-risks">FULL ARTICLE</a></span></p>
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<hr />
<p><a name="f"></a><br /><strong>The Role of Governance in the Dallas Police and Fire Pension Crisis</strong></p>
<p>There are several factors influencing the declining solvency of the Dallas Police &amp; Fire Pension System (DPFP), including risky investments, generous DROP returns, and large lump-sum withdrawals. Further complicating the situation, Dallas Mayor Mike Rawlings recently requested an investigation of potential unspecified criminal activities conducted by previous DPFP administrators. In a new blog post, Reason's Anil Niraula writes that the actual causes behind the plan's misfortunes apparently go far deeper than any possible past criminality and point directly to the way the retirement system is governed.<br /><span style="font-size: 80%; color: red;">&raquo; <a href="http://reason.org/blog/show/governance-dallas-police-and-fire">FULL BLOG POST</a></span></p>
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<hr />
<p><a name="j"></a><strong><span style="font-size: 120%;">Quotable Quotes on Pension Reform</span></strong></p>
<p>"In an overall portfolio context, the return for a simple 60% world equity and 40% U.S. aggregate bond portfolio [in 2017] is expected to be in the neighborhood of 5.5% to 6.0%, roughly 75 basis points below our 2016 assumptions. Volatility forecasts are also marginally higher."<br /><br />&mdash;Anne Lester, head of retirement solutions for J.P. Morgan's global investment management solutions group, quoted in John Manganaro, "<a href="http://www.plansponsor.com/Long-Term-Return-Assumptions-Reduced-Again-for-2017/?fullstory=true">Long-Term Return Assumptions Reduced Again for 2017</a>," Plansponsor.com, January 10, 2017.</p>
<p><br />"All models developed in 2016 indicated a likelihood of 35 percent or less of actual long-term future average returns meeting or exceeding 7.6 percent."<br /><br />&mdash;Florida Department of Management Services' annual report on the financial status of the state pension system (which lowered its assumed rate of return to 7.6 percent in October 2016), quoted in News Service of Florida, "<a href="http://www.orlandosentinel.com/news/politics/os-pension-fund-florida-20170105-story.html">Projected pension returns could be too rosy, report says</a>,&rdquo; <em>Orlando Sentinel</em>, January 5, 2017.</p>
<p><br />"It was an unsustainable feature. [...] What they turned it into was an investment strategy and guaranteed themselves a return that is unheard of."<br /><br />&mdash;Dallas, TX City Manager A.C. Gonzalez on the Dallas Police &amp; Fire Pension System's historical policy of guaranteeing 8-10% annual interest on the balances in individuals' deferred retirement option plans (DROP), quoted in Tanya Eiserer, "<a href="http://www.wfaa.com/news/dallas-police-and-fire-pension-members-may-have-to-pay-back-funds/382652927">Dallas Police and Fire pension members may have to pay back funds</a>," WFAA.com, January 5, 2017.</p>
<p><br />"We're not on the brink of running out of money. But what we are is at a much higher risk profile than we&rsquo;re comfortable with. That's not just a risk for members. That's a risk for employers, that's a risk for taxpayers, that's a risk for Colorado communities."<br /><br />&mdash;Greg Smith, Colorado Public Employee Retirement Association executive director, quoted in, Brian Eason, "<a href="http://www.denverpost.com/2017/01/20/pera-colorado-growing-pension-concerns/">PERA at risk of insolvency if another recession comes, director says</a>," <em>The Denver Post</em>, January 20, 2017.</p>
<p><br />"Providing DB benefits is expensive, and any time you backload pay (for you or someone else), it is tempting to not put enough money aside. The combination of high cost and bad incentives is what killed the pension plan. Or, it was ERISA, which forced pension plans to account for the cost and fund pensions properly. It is telling that the only industry where [pensions] are still common is the one not subject to ERISA, state and municipalities. Don't blame the 401(k) for the fact you don&rsquo;t have a DB plan!<br /><br />And DB plans are risky. Risk is one reason why they are so expensive for employers. Moving a stream of income from today into the future is expensive to insure."<br /><br />&mdash;Allison Schrager, "If liking 401(k) accounts is wrong, I don't want to be right," Allison's Ode to the Second Moment (e-newsletter), January 9, 2017.</p>
<p><span style="font-size: 80%;">&raquo; <a href="#top">return to top</a></span></p>
<hr />
<p><a name="k"></a><strong><span style="font-size: 120%;">Contact the Pension Reform Help Desk</span></strong></p>
<p>Reason Foundation's Pension Reform Help Desk provides information and technical resources for those wishing to pursue pension reform in their states, counties and cities. Feel free to contact the Reason Pension Reform Help Desk by e-mail at <a href="mailto:pensionhelpdesk&#64;reason.org">pensionhelpdesk&#64;reason.org</a>.</p>
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<p><em>Follow the discussion on pensions and other governmental reforms at <a href="http://www.reason.org">Reason Foundation's website</a> or on Twitter (<a href="https://twitter.com/ReasonReform?lang=en">&#64;ReasonReform</a>). As we continually strive to improve the publication, please feel free to send your questions, comments and suggestions to <a href="mailto:leonard.gilroy&#64;reason.org">leonard.gilroy&#64;reason.org</a>.</em></p>
<p>Leonard Gilroy<br />Senior Managing Director, Pension Integrity Project<br />Reason Foundation<br /><br />Anthony Randazzo<br />Managing Director, Pension Integrity Project<br />Reason Foundation</p>1014782@http://www.reason.orgMon, 30 Jan 2017 10:00:00 ESTleonard.gilroy@reason.org (Leonard Gilroy)Pension Debt: The Still Unsolved Problem Threatening Lincolnhttp://www.reason.org/news/show/lincoln-pension-debt-problem
<p>The Lincoln Police and Fire Pension Fund (PFPF) defined benefit pension plan has just under 600 active members and nearly 400 retirees.<a href="#_ftn1" name="_ftnref1"></a> The city reported earlier in 2016 that it has promised an estimated $286.4 million in retirement benefits to this group of public safety employees and retirees, but exactly how many benefits have really been promised and what is saved to pay for them is up for some debate. In June 2016, Lincoln passed an ordinance that &mdash; in part &mdash; changed how PFPF values all promised pension benefits in a way that lowered the recognized value of benefits promised to an amount around $250 million.<a href="#_ftn2" name="_ftnref2"></a> The actual amount of normal retirement benefits didn&rsquo;t change, just the accounting method used to add up all estimated future pension checks and then translate those streams of future payments into a single amount reported in today&rsquo;s dollars.</p>
<p>Unfortunately, the change adopted by Lincoln &mdash; specifically, increasing the &ldquo;discount rate&rdquo; used to value liabilities from 6.4% to 7.5% &mdash; was a step in the wrong direction for pension solvency. Using accounting methods more widely accepted amongst financial economists and closer to those used by private sector defined benefit plans, Lincoln taxpayers may actually be on the hook for closer to $345 million in promised pension benefits.<a href="#_ftn3" name="_ftnref3"></a></p>
<p>This conclusion is based on analysis of PFPF that we have recently co-published in a new policy study with Nebraska's Platte Institute. The study outlines the problems facing Lincoln, provides a quantitative forecast for what unfunded liabilities will look like in the coming years if there are no changes to the pension plans, and details a series of solutions that can address these challenges.&nbsp;</p>
<p><strong>Read the full report <a href="http://reason.org/files/lincoln_pension_debt_platte-reason.pdf">here</a>.</strong></p>
<p>The discrepancy in how much Lincoln's pension debt really amounts to is reflective of a fundamental challenge facing Lincoln PFPF: whether the actuarial accounting practices used by the city and PFPF board accurately reflect the value of the promised pension benefits. This is a problem for Lincoln today, and it has been a major part of why unfunded liabilities have grown for PFPF in the first place.</p>
<p>Until 2008, PFPF reported that it had more assets on hand than the value of all promised benefits &ndash; i.e., it was &ldquo;over-funded.&rdquo; In fact, from the late 1990s through the late 2000s, Lincoln PFPF reported funding ratios of between 100% and 130%. Since, the financial crisis, however, the public safety pension fund has seen its funding ratio consistently hover around 80% &mdash; assuming we count assets set aside for Lincoln&rsquo;s 13<sup>th</sup> Checks. Another change Lincoln made in June 2016 was to merge an asset pool set aside to pay out so-called &ldquo;13<sup>th</sup> Checks&rdquo; &mdash; a sort of cost-of-living adjustment (COLA) &mdash; with the pool of assets for normal retirement benefits.<a href="#_ftn4" name="_ftnref4"></a></p>
<p>Since the early 1990s, PFPF paid out 13<sup>th</sup> Checks, but didn&rsquo;t pre-fund the benefit with normal cost, instead paying for the COLAs by siphoning off a certain amount of investment returns in years where the market was strong. Merging the asset pool for COLAs and normal retirement benefits &mdash; and subsequently adopting a proposal to guarantee the COLA &mdash; means that PFPF will report a larger amount of assets in future years, but in practice, the combined money has always been a part of PFPF.</p>
<p>Focusing just on the assets PFPF has recognized as available to pay normal benefits, the funded ratio at the end of 2015 was just 62%. Absent reform, the funding ratio will probably dip further in coming years.<a href="#_ftn5" name="_ftnref5"></a></p>
<p>The financial crisis effectively exposed serious, systemic problems with the funding polices for PFPF:</p>
<ul style="list-style-type: square;">
<li>Problem 1: Prior to 2008, Lincoln consistently paid less than the actuarially recommended amount into the system annually, and was able to do so because favorably timed investment returns helped paper over the shortchanging contributions.</li>
<li>Problem 2: Prior to 2008, the city chose to adjust its asset allocation to increase the percentage of high-yield, high-risk investments because doing so allowed the plan to make up for falling yields in lower-risk assets like bonds and keep a 7.5% assumed rate of return. As market conditions changed and the returns for low-risk investments fell over the past few decades, the city could have kept it allocation of assets fixed and simply lowered the assumed return. But, in order to avoid the additional contributions this would have required, Lincoln added investment risk. This only exacerbated the losses in the financial crisis when they happened.</li>
<li>Problem 3: Prior to 2008, the discount rate for PFPF didn't change, even as &ldquo;risk free&rdquo; rates of return plummeted for decades, ultimately leaving liabilities undervalued. If Lincoln had pegged the discount rate it used for PFPF to the rate of change in 30-year treasuries starting in 2001, then by 2008 instead of reporting a 100% funded plan, Lincoln would have reported PFPF as only 82% funded with $39 million in unfunded liabilities.<a href="#_ftn6" name="_ftnref6"></a></li>
</ul>
<p>Our conclusion based on analysis of these problems is that Lincoln moved in the right direction when it reduced its assumed return rate down to 6.4% to better reflect market conditions. But by reversing this decision and increasing the assumed return back to 7.5% (after the 13<sup>th</sup> Check asset pool merger), Lincoln failed to address the underlying problem facing PFPF and further exacerbated the problems inherent in the existing system. Despite efforts to address pension issues over the past decade in one form or another, PFPF unfunded liabilities are still likely to continue growing and harm Lincoln finances.</p>
<p>See <a href="http://reason.org/files/lincoln_pension_debt_platte-reason.pdf">the full report</a>&nbsp;for our actuarial forecasting of PFPF, as well as details on the policy solutions we recommend Lincoln consider to solve its problems.</p>1014768@http://www.reason.orgWed, 25 Jan 2017 07:00:00 ESTdaniel.takash@reason.org (Daniel Takash )Pension Debt: The Billion Dollar Problem Still Threatening Omahahttp://www.reason.org/news/show/omaha-pension-debt-problem-2
<p>Since 2007, Omaha&rsquo;s pension plans have been assuming that investment returns on the assets of pension fund members would earn an average return of 8% a year.&nbsp; In 2015, however, the plans earned a return of just 0.2% for the Police and Fire Retirement System (PFRS) and 3.1% for the Employees&rsquo; Retirement System (ERS), and the actuary for the plans reported that 2016 would need to see a return of 13% in order to put them on their expected 8% rate of return pace.&nbsp;Strong evidence suggests that the actual return for 2016 will be considerably lower than that, and almost certainly will be less than the expected 8% again.&nbsp;And in the process, taxpayers will see millions of dollars of unfunded liability added to the city&rsquo;s two defined benefit plans.&nbsp;</p>
<p>While one or two years of investment returns should never be the singular focus when analyzing a pension plan, the past two years are representative of both the historic underperforming trend for Omaha&rsquo;s pension plans, as well as the forecasted future of lower expected returns for pension funds than even the past. The unfortunate reality is that despite changes made to Omaha&rsquo;s retirement systems in 2015, growing pension debt remains a considerable threat in the coming years absent further reform.</p>
<p>This conclusion is based on analysis of PFRS and ERS that we have recently co-published in a new policy study with Nebraska's Platte Institute. The study outlines the problems facing Omaha, provides a quantitative forecast for what unfunded liabilities will look like in the coming years if there are no changes to the pension plans, and details a series of solutions that can address these challenges.&nbsp;</p>
<p><strong>Read the full report <a href="http://reason.org/files/omaha_pension_debt_platte-reason.pdf">here</a>.</strong></p>
<p>&nbsp; ---</p>
<p>The good news for Omaha is that things could be worse. In 2015, Mayor Jean Stothert signed a collective bargaining agreement with civilian labor unions that, in part, created a new &ldquo;cash balance&rdquo; retirement plan for new members of ERS. This cash balance plan guarantees a 4% rate of return on contributions to member&rsquo;s retirement accounts and shares 75% of investment returns above 7% with plan members. Thus, every member hired after March 1, 2015, when this cash balance plan was adopted, is an employee whose pension liabilities are not exposed to the actuarial assumptions of the civilian defined benefit plan.</p>
<p>While the data is not yet final, general market returns during the 2016 fiscal year suggest that Omaha will certainly see market rates of return less than the assumed 8% return target. As such, we can safely assume that unfunded liabilities are going to be lower in 2017 &mdash; if even by a small amount &mdash; than if the cash balance plan had not been implemented.&nbsp;</p>
<p>That is the extent of the good news for Omaha, though, as we outline in this report. PFRS saw its unfunded liabilities grow by $40.7 million during fiscal year 2015, and it remains exposed to even further pension debt growth. Changes made to benefits in 2010 and 2013 slightly reduced the growth of unfunded liabilities, but they did not fundamentally change the underlying funding policy factors that have been the drivers of unfunded liabilities. Plus, while the adoption of a cash balance plan for new civilian hires in 2015 was a positive step toward meaningful pension reform, the funding policy for the existing plan must be adjusted in order to prevent the existing liabilities from experiencing continued underfunding. Thus, there are several other steps that should be taken in order to protect Omaha&rsquo;s taxpayers from seeing their tax dollars consumed by unfunded liability amortization payments.</p>
<p>In 2014, we highlighted several problematic trends associated with Omaha&rsquo;s billion-dollar problem with a <a href="http://bit.ly/2fwOetG">policy study co-published</a>&nbsp;with Platte Institute. This new policy study follows up on that work and identifies three underlying causes for the pension debt that continues to weigh down Omaha:</p>
<ol>
<li>Not Paying the Full Actuarially Determined Employer Contribution
<ul>
<li>Omaha has a history of not always contributing 100% of this actuarially calculated contribution rate.&nbsp;Collectively, since 1994, the city has paid only 73% of the ADEC for PFRS&rsquo;s, and 62% of ERS&rsquo;s total ADEC.</li>
</ul>
</li>
<li>Underperforming Investment Returns
<ul>
<li>Omaha's plans have averaged returns of between 4.5% and 4.8% over the past 10 and 15 year time periods, respectively, all while assuming 8% rates of return. Even a 20-year average for ERS at 6% is well below what the plans have been assuming. And based on the asset allocation of PFRS and ERS, it is a virtual certainty that the plans will continue to have average returns underperform long-term expectations without a meaningful change to funding policy.&nbsp;</li>
</ul>
</li>
<li>Undervalued Liabilities
<ul>
<li>Unfortunately, even if investments were performing as expected over the long run, Omaha may still have seen unfunded liability amortization payments grow over the past few years. This is because the plan is undervaluing the amount of all promised future benefits in today&rsquo;s dollars. If Omaha were to use a "discount rate" that more accurately prices accrued liabilities, the combined reported unfunded liability would be more than double the existing recognized amount to near $2 billion and the total funded ratio would fall to only 29%.</li>
</ul>
</li>
</ol>
<p>Our conclusion is that the cash balance plan for ERS was a good first step toward improved solvency, but the existing liabilities of the defined benefit plan in that system are still exposed to the risk of underperforming the plan&rsquo;s assumed rate of return. The same risks exist for the liabilities of the PFRS defined benefit plan. So despite efforts to address pension issues over the past decade in one form or another, unfunded liabilities are still likely to continue growing and harm city finances &mdash; just as leaving toxic waste alone without cleaning it up is likely to lead to increased environmental damage.&nbsp;</p>
<p>See <a href="http://reason.org/files/omaha_pension_debt_platte-reason.pdf">the full report</a>&nbsp;for our actuarial forecasting of PFRS and ERS, as well as details on the policy solutions we recommend Omaha consider to solve its problems.&nbsp;</p>1014767@http://www.reason.orgTue, 24 Jan 2017 07:00:00 ESTtruong.bui@reason.org (Truong Bui)Pension Reform Newsletter - December 2016http://www.reason.org/news/show/pension-reform-newsletter-dec16
<p>This newsletter from Reason Foundation's Pension Integrity Project highlights articles, research, opinion, and other information related to public pension challenges and reform efforts across the nation. You can find previous editions <a href="http://reason.org/newsletters/pensionreform/">here</a>.</p>
<p><strong><span style="font-size: 120%;">In This Issue:</span></strong></p>
<p><strong><a href="#a">Articles, Research &amp; Spotlights</a></strong></p>
<ul type="disc">
<li><a href="#b">CalPERS Lowers Assumed Rate of Return to 7%</a></li>
<li><a href="#c">Dallas Pension Crisis Prompts Credit Rating Downgrade, DROP Withdrawal Ban</a></li>
<li><a href="#d">2016 Pension Litigation Year-in-Review</a></li>
<li><a href="#e">Study Identifies Enormous Risk in Public Pension Investments</a></li>
<li><a href="#f">Misconceptions About Economic Impacts of Retiree Pension Spending</a></li>
<li><a href="#g">Kentucky Teachers Sue State Over Pension Underfunding</a></li>
</ul>
<p><strong><a href="#i">News in Brief</a></strong></p>
<p><strong><a href="#j">Quotable Quotes on Pension Reform</a></strong></p>
<p><strong><a href="#k">Contact the Pension Reform Help Desk</a></strong></p>
<hr />
<p><a name="a"></a><strong><span style="font-size: 120%;">Articles, Research &amp; Spotlights</span></strong></p>
<p><a name="b"></a><br /><strong>CalPERS Board Lowers Assumed Rate of Return to 7.0%</strong></p>
<p>Last week, the board of the California Public Employees' Retirement System (CalPERS) voted to reduce the plan's assumed rate of return on its investment portfolio from 7.5% down to 7.0% over the next three years. The move is expected to result in $2 billion in additional employer contributions over the next several years. While a significant reduction, CalPERS' investment advisor forecasts average returns of just 6.2% over the coming decade. As a bellwether of the U.S. public pension sector, CalPERS' move is likely to prompt other public plans to reconsider their current return assumptions. <br /> <span style="font-size: 80%; color: red;">&raquo;</span><span style="font-size: 80%;"> MORE INFORMATION: <a href="http://www.reuters.com/article/us-california-calpers-idUSKBN14A2EE">Reuters</a> | <a href="http://www.latimes.com/projects/la-me-pension-changes/">L.A. Times</a> | <a href="https://www.bloomberg.com/news/articles/2016-12-23/california-to-pay-billions-more-after-calpers-cuts-assumed-rate">Bloomberg</a> | <a href="https://edsource.org/2016/calpers-cuts-earnings-forecast-school-districts-to-pay-more-for-pensions/574612">EdSource.org</a></span><br /> <span style="font-size: 80%; color: red;">&raquo;</span><span style="font-size: 80%;"> RELATED: <a href="http://reason.org/blog/show/calpers-says-75-returns-unlikely">CalPERS Says 7.5% Returns Over the Next Decade Unlikely</a></span></p>
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<p><a name="c"></a><br /><strong>Dallas Pension Crisis Prompts Another Credit Rating Downgrade and Ban on DROP Withdrawals</strong></p>
<p>The Dallas Police &amp; Fire Pension System (DPFP) has made headlines recently due to its massive unfunded liabilities, a virtual "run" on the system since August&mdash;with an estimated $500 million in withdrawals&mdash;and its unsustainable deferred retirement option plan (DROP). In a blog post this week, Reason's Anil Niraula and Leonard Gilroy highlight two recent developments in this evolving story: a second credit rating downgrade by Moody's this year prompted by the pension crisis, and a move by the DPFP board to place a moratorium on DROP withdrawals. <br /> <span style="font-size: 80%; color: red;">&raquo; <a href="http://reason.org/blog/show/dallas-pension-crisis-dec-update">FULL ARTICLE</a></span></p>
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<hr />
<p><a name="d"></a><br /><strong>2016 Pension Litigation Year-in-Review</strong></p>
<p>With pension reform, signing policy into law isn't the end of the story. Benefit reductions, changes to retirement ages, contribution increases, and other reform measures often face legal challenges, and 2016 was no exception. As Reason's Daniel Takash writes, it has been a good year for pension reformers overall, though legal hurdles still need to be cleared in some states.<br /> <span style="font-size: 80%; color: red;">&raquo; <a href="http://reason.org/news/show/2016-pension-litigation-year-in-rev">FULL ARTICLE</a></span></p>
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<hr />
<p><a name="e"></a><br /><strong>Study Identifies Enormous Risk in Public Pension Investments</strong></p>
<p>While the accounting practices adopted by most public pension plans have been extensively condemned in recent research, few people pay attention to the risks inherent in investments taken by those plans. For example, a popular criticism of public pension plan discount rates is that they undervalue pension liabilities by not reflecting the risk of those liabilities, and that the expected returns assumed by those rates are too high and unrealistic. However, the asset allocations designed to achieve those returns can yield a wide range of outcomes, and the distribution of these outcomes can have significant effects on pension costs. In a recent article, Reason's Truong Bui examines new academic research on this issue.<br /> <span style="font-size: 80%; color: red;">&raquo; <a href="http://reason.org/blog/show/study-identifies-enormous-risk-in-p">FULL ARTICLE</a></span></p>
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<hr />
<p><a name="f"></a><br /><strong>Do Retirees With Defined Benefit Pensions Spend Differently Than Those With Defined Contribution Accounts?</strong></p>
<p>Earlier this year the National Institute on Retirement Security (NIRS) released a report claiming that defined benefit (DB) plans are better for local economies than defined contribution plans. The argument is rooted in the idea that DB plans generate superior "multiplier" effects on state and local economies through retiree spending. NIRS further argues that because pension checks don't change during market downturns, DB plans also stabilize local economies in times of financial turmoil. Unfortunately, the NIRS report is full of logical flaws, as Reason's Anil Niraula and Anthony Randazzo write in a recent article.<br /> <span style="font-size: 80%; color: red;">&raquo; <a href="http://reason.org/news/show/do-retirees-with-db-benefits-differ">FULL ARTICLE</a></span></p>
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<hr />
<p><a name="g"></a><br /><strong>Can Kentucky Teachers Hold the Commonwealth to Its Pension Promises?</strong></p>
<p>Do states have a legal requirement to fully fund their employees' pension plans? As Reason's Daniel Takash explains in a recent blog post, this is the question at the heart of a lawsuit recently filed by Kentucky's public school teachers against Governor Matt Bevin and the state legislature for underfunding the Kentucky Teachers' Retirement System.<br /> <span style="font-size: 80%; color: red;">&raquo; <a href="http://reason.org/blog/show/can-kentucky-teachers-hold-the-comm">FULL ARTICLE</a></span></p>
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<hr />
<p><a name="i"></a><strong><span style="font-size: 120%;">News in Brief</span></strong></p>
<p><span style="text-decoration: underline;">New State/Local Government Worker Retirement Survey</span>: A new survey released by the TIAA Institute and the Center for State &amp; Local Government Excellence examines the retirement planning and saving decisions of full-time state and local government workers, as well as their confidence in their retirement income prospects. Among its many findings, the survey found that 88% of government workers are very or somewhat confident that they will receive the full retirement plan benefits they have earned. The full report is <a href="https://www.tiaainstitute.org/public/pdf/2016_retirement_confidence_survey.pdf">available here</a>.</p>
<p><span style="text-decoration: underline;">Utah State Auditor Report Puts School-Related Pension Debt into Perspective</span>: A new analysis by the Utah Office of the State Auditor finds that if there were no pension debt, the unfunded liability amortization payments made by Utah school districts in 2015 could have been used instead to reduce education expenses by 3.7%, increase teacher pay by 14%, increase the weighted pupil unit by almost 7.5%, raise public education employee wages by approximately 8.5%, double the number of teacher aides and paraprofessionals inside classrooms, or operate an additional 40 elementary schools or several hundred new classrooms. The full report is <a href="http://financialreports.utah.gov/saoreports/2016/AR16-03EducationPensionCostsEducation,Officeof.pdf">available here</a>.</p>
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<p><a name="j"></a><strong><span style="font-size: 120%;">Quotable Quotes on Pension Reform</span></strong></p>
<p>"There's no doubt [CalPERS] needs to start aligning its rate of return expectations with reality"<br /><br />&mdash;California Gov. Jerry Brown, quoted in Heather Gillers, "<a href="http://www.wsj.com/articles/americas-largest-pension-fund-a-7-5-annual-return-is-no-longer-realistic-1481721719">America's Largest Pension Fund: A 7.5% Annual Return Is No Longer Realistic</a>," <em>The Wall Street Journal</em>, December 14, 2016.</p>
<p><br />"If you care about this system, if you're concerned about the payment of benefits to members, the most important thing we can do is shore up the funding. And we can't wait to do that. It's pay now or pay more later."<br /><br />&mdash;CalPERS board member Richard Gillihan, quoted in Dan Walters, "<a href="http://www.fresnobee.com/news/politics-government/article120065078.html">Two decisions could make big changes in California's public pension system</a>," <em>Sacramento Bee</em>, December 11, 2016.</p>
<p><br />"Absent reform, pension costs will crowd out more than $1 trillion of California public services over the next 30 years. <em>It doesn't take a social scientist to grasp that civil society is at risk when so many people are being disappointed</em>, especially when there is perceived unfairness because not all citizens suffer the consequences (e.g., parents who can afford to send their kids to private schools). Elected officials must understand pension math and work towards a solution."<br /><br />&mdash;David Crane, "<a href="https://medium.com/&#64;DavidGCrane/clearing-up-some-pension-math-72a0b4bd1127#.6sr1ml2qw">Clearing Up Some Pension Math</a>," Medium.com (blog), December 4, 2016.</p>
<p><br />"The [Michigan Public School Employee Retirement System] now devours 36 percent of school payroll costs. Teachers may fear not having a traditional pension, but the reality is that if left unaddressed the current trajectory will contribute to other negative impacts, such as less money for pay raises and other cuts to the classroom."<br /><br />&mdash;"<a href="http://www.detroitnews.com/story/opinion/editorials/2016/12/13/school-pension/95410934/ ">Put pensions on to-do list</a>," (editorial) <em>The Detroit News</em>, December 13, 2016.</p>
<p><br />"Everyone wants to keep their job, I get that. And I don't want to hurt anyone's retirement. But I also don&rsquo;t want to hurt future generations of learners and teachers, and state police and others. How is it fair to our students to cut current teachers to pay for retired ones?"<br /><br />&mdash;Former Oregon Investment Council Chairwoman Katy Durant, quoted in, &ldquo;<a href="http://www.statesmanjournal.com/story/opinion/2016/12/17/oregon-public-employees-retirement-system-does-not-need-denial/95379762/">Denial not a solution for Oregon's public employees retirement system</a>&rdquo; (editorial), <em>Statesman Journal</em>, December 17, 2016.</p>
<p><br />"All we know is that interest rates have popped up a little bit and equity prices have run up over the last three weeks. How that's going to filter into the ingredients that go into forecasting long-term returns, it's too early to tell."<br /><br />&mdash;Milliman actuary Alan Perry, quoted in Vipal Monga and Heather Gillers, "<a href="http://www.wsj.com/articles/dow-20-000-wont-wipe-away-pension-problems-1481711401">Dow 20000 Won't Wipe Away Pension Problems</a>," <em>The Wall Street Journal</em>, December 14, 2016.</p>
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<hr />
<p><a name="k"></a><strong><span style="font-size: 120%;">Contact the Pension Reform Help Desk</span></strong></p>
<p>Reason Foundation's Pension Reform Help Desk provides information and technical resources for those wishing to pursue pension reform in their states, counties and cities. Feel free to contact the Reason Pension Reform Help Desk by e-mail at <a href="mailto:pensionhelpdesk&#64;reason.org">pensionhelpdesk&#64;reason.org</a>.</p>
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<p><em>Follow the discussion on pensions and other governmental reforms at <a href="http://www.reason.org">Reason Foundation's website</a> or on Twitter (<a href="https://twitter.com/ReasonReform?lang=en">&#64;ReasonReform</a>). As we continually strive to improve the publication, please feel free to send your questions, comments and suggestions to <a href="mailto:leonard.gilroy&#64;reason.org">leonard.gilroy&#64;reason.org</a>.</em></p>
<p>Leonard Gilroy<br />Senior Managing Director, Pension Integrity Project<br />Reason Foundation<br /><br />Anthony Randazzo<br />Managing Director, Pension Integrity Project<br />Reason Foundation</p>1014762@http://www.reason.orgFri, 30 Dec 2016 12:00:00 ESTleonard.gilroy@reason.org (Leonard Gilroy)Why Florida State Worker Pensions Are In a Picklehttp://www.reason.org/news/show/why-florida-state-worker-pensions-a
Florida Business Observer <p>This fall, Florida&rsquo;s top pension plan investment manager is singing the praises of his fund that managed to wring out a feeble 0.61% return on investments this fiscal year. <br /> <br />&ldquo;The positive net returns show the value of diversification, our success in controlling costs, and the prudence and patience of sticking to the fund&rsquo;s long-term investment plan in a challenging year,&rdquo; said Ash Williams, executive director of the State Board of Administration, which manages investments for the Florida Retirement System. <br /> <br />It&rsquo;s nice that he wants to be so cheerful, but there is a problem with the positivity. It&rsquo;s based on an idea that the goal is to simply get returns greater than 0% each year. But pension systems need to do more than just avoid losing money. For the Florida Retirement System, the goal is to get returns greater than 7.65%. <br /> <br />There is nothing particularly special about a pension plan&rsquo;s return being above a threshold of 0%, or avoiding a negative sign getting attached the annual rate of return figure. Like all defined benefit plans, FRS has an assumed rate of return that is used in calculating how much should be contributed to the plan each year. That assumed rate is the average return the plan expects to get over the long-term &mdash; a 20-year to 30-year time horizon. For FRS to average at least 7.65%, the plan has to have a number of years with returns above that benchmark to make up for the years where returns underperform a 7.65% threshold. <br /> <br />In this context &mdash; needing to hit an average of 7.65% for long-term solvency &mdash; the year&rsquo;s investment returns simply being in positive territory isn&rsquo;t important. <br /> <br />Whether a return is negative 1%, 0% or 1% in any given year isn&rsquo;t all that different for the long-term average. If FRS had reported a return of negative 0.61% it wouldn&rsquo;t have made much of a difference for the plan&rsquo;s long-term goal of a 7.65% return relative to a 0.61% return. <br /> <br />Yet, nowhere in Williams&rsquo;s last presentation to Gov. Rick Scott and his cabinet was this emphasized. In fact, it framed the 0.61% return as one that &ldquo;keeps alive a streak&rdquo; of positive investment gains for the seventh straight year in a row. <br /> <br />This is an utterly meaningless &ldquo;streak.&rdquo; <br /> <br />If we want to look at the streaks for FRS, the point of measurement should be the number of years it has returned above or below 7.65%. The chart above on the right shows a 40-year history of FRS investment return data to look for such streaks. <br /> <br />Looking at the past four decades, the FRS rate of return has surpassed the 7.65% assumed return 24 times. And within that context, the longest &ldquo;streak&rdquo; of gains above the targeted rate is six years &mdash; back in in the mid-1990s. I&rsquo;m not exactly sure how meaningful such streaks are, but if anyone wants to sing praises about a streak, this would be the kind to think about. <br /> <br />What we are sure about is that even these streaks don&rsquo;t tell us much about the future. <br /> <br />Today&rsquo;s markets are not like the 1990s. In fact, the trend in large gains is getting smaller over time. There have been only eight years with returns above the targeted rate in the past 15 years, and only five good years in the past 10. The smaller &ldquo;streaks&rdquo; of strong investment returns reflects the change in markets, and the new normal in what are reasonable expectations for investments returns. <br /> <br />The 20-year average rate of return for FRS is 7.3%, but the 10-year average is 5.9% reflecting the lower returns available in modern markets. Theoretically any 10-year snapshot could be cherry picked to show a good or bad average return, but the reality is for FRS to have a 20-year average return of 7.65% by 2026 &mdash; i.e. get the 20-year average up to the assumed return over the next decade &mdash; the Florida pension fund needs to average a return of at least 9.5% for the next 10 years. <br /> <br />And that is going to take a lot of big investment years. Just cruising over a 0% threshold isn&rsquo;t going to cut it. <br /> <br />Unfortunately for pension plans with assumed rates of return over 6% (which is nearly all of them across the United States), yields on equities and bonds are forecast to be considerably lower over the next few decades relative to the past. For example, according to McKinsey &amp; Co.&rsquo;s most recent forecast, returns on U.S. equities are likely going to be 20% to 50% lower over the next 20 years than the last 30. <br /> <br />In his report to the Florida governor, Williams did accurately note that with recent market trends &ldquo;it&rsquo;s a very different world.&rdquo; However, because it is so different than the era when a pension plan could just invest mostly in bonds and get an average return of around 8%, it is inappropriate to describe 0.61% returns for a fund with a 7.65% targeted return rate as a &ldquo;success.&rdquo; <br /> <br />Two straight years, with returns below the targeted average &mdash; and three of the past five &mdash; should be taken as a warning sign that Florida, California, and all states with defined benefit or cash balance pension plans need to do something different. At a minimum, pension plans should consider lowering their expectations and risk exposure, adopt lower assumed rates of return, and ensure they are making the necessary contributions to fund the pension obligations being placed on the shoulders of taxpayers. <br /><br /> <em>Adrian Moore is vice president of the Reason Foundation and lives in Sarasota. Anthony Randazzo is managing director of Reason&rsquo;s Pension Integrity Project. </em><a href="http://www.businessobserverfl.com/section/detail/why-florida-state-worker-pensions-are-in-a-pickle/"><strong><em>This column first appeared in the Florida Business Observer.</em></strong></a></p>1014822@http://www.reason.orgThu, 15 Dec 2016 10:01:00 ESTadrian.moore@reason.org (Adrian Moore)Do Retirees With Defined Benefit Pensions Spend Differently Than Those With Defined Contribution Accounts?http://www.reason.org/news/show/do-retirees-with-db-benefits-differ
<p>Earlier this year the National Institute on Retirement Security (NIRS) <a href="http://www.nirsonline.org/storage/nirs/documents/Pensionomics%202016/pensionomics2016_final.pdf">released a report</a> claiming that defined benefit (DB) plans are better for local economies than defined contribution (DC) plans. The argument is rooted in the idea that DB plans generate superior &ldquo;multiplier&rdquo; effects on state and local economies through retiree spending. NIRS further argues that because pension checks don&rsquo;t change during market downturns, DB plans also stabilize local economies in times of financial turmoil. Unfortunately, the NIRS report is full of logical flaws.</p>
<p>Let&rsquo;s start with a consideration of the report&rsquo;s methodology.</p>
<p>The NIRS study attempts to &ldquo;quantify the economic impact of DB pension payments in the U.S. and in each of the 50 states&hellip;&rdquo; using the so-called &ldquo;multiplier&rdquo; concept (also known in economics as Keynesian multiplier). The idea is that different kinds of spending influence economic growth in different kinds of ways. Certain expenditures become the income of other people, and other expenditures get reinvested. And to the degree that we can trace the effects of certain kinds of expenditures, as they are multiplied throughout the economy, we can put a value judgment on the efficacy of certain sources of income from the perspective of economic growth. However, whether this can even be done accurately is a matter of <a href="http://voxeu.org/article/government-spending-multipliers-and-business-cycle">persistent debate</a> among economists.</p>
<p>The NIRS authors explain their methodology of&nbsp;calculating the multiplier as dividing the &ldquo;total output supported by retiree expenditures by total pension payments made in that year.&rdquo; This poses several challenges for measurement of both the <a href="https://msu.edu/user/stynes/mirec/concepts.htm">direct and indirect effects of pensioner expenditures</a>. In particular, the analysts would need to know what percentage of benefits received by retirees are actually spent (<a href="http://people.cedarville.edu/employee/wheelerb/macro/ae/multiplier/multiplier.htm">and not saved</a>), and what kinds of expenditures are being made.</p>
<p>Perhaps even more important for a local multiplier estimate to be made, analysts would need to know whether retiree spending/consumption is done within the state or municipality sponsoring the defined benefit plan or if those dollars are being spent elsewhere &mdash; i.e., for the multiplier to be valid, it should only apply to spending that is "captured" locally and is not diverted outside the area.</p>
<p>Given the complexity of such calculations and the granularity of data required, it becomes almost impossible to validate all of the aforementioned estimates without significant simplification.</p>
<p>All pension plans have some data on where their retirees live because they have to pay out the benefits. Thus, doing a more focused study on just one plan might, in theory, reduce the degree of difficulty in this analysis. But even then it is challenging to effectively trace all retiree dollars given the propensity of retirees to travel. And that is all before considering there is <a href="http://www.govtmultiplier.com">no consistent empirical evidence</a> that spending of any kind actually generates more economic income than the amount actually spent.</p>
<p>But assuming for the moment that a multiplier for retiree spending could be calculated, what about the logic of the NIRS argument?</p>
<p>For any given municipal area, whether or not a retiree spending multiplier is greater than one depends heavily on whether retirees stay. There is no means of control on retiree mobility, nor a guarantee that retiree income&mdash;no matter the source&mdash;will stay in a given local economy. (In fact, this line of reasoning might be better served making an argument that pensions are transfers of resources from taxpayers in colder, northern states to the local economies of warmer, southern states. But at that point the argument is mostly just a commentary on the economic benefits of tourism and demographic mobility.)</p>
<p>Of course, if the analysis is brought up to a national level, this problem for the NIRS paper logic goes away. But another problem replaces it: is there a lot of spending by retirees across the United States? Sure. But that doesn&rsquo;t say anything about whether defined benefit plans are the necessary source of providing that money to be spent. Whether a retiree&rsquo;s bank account is fed by checks from defined benefit plans, cash balance plans, or defined contribution plans the money is always the same color. While the authors admit that DB and DC plans are similar in that they deliver comparable retirement benefits, they fail to acknowledge that retirees' spending may in fact have the same effects on state and local economies regardless of the type of retirement plan they are attached to.</p>
<p>Could consumption patterns of retirees in DB plans be in any way different from those in defined contribution or any other type of retirement plans? The authors argue that because defined benefits are fixed for the retirees and don&rsquo;t change even during&nbsp;market downturns, then retiree spending patterns won&rsquo;t change as the result of something like a recession, thereby &ldquo;stabilizing&rdquo; local economies. But this analysis ignores that:</p>
<ul>
<li>Cash balance plans and DC plans can be designed to pay out fixed annuities upon retirement just like DB plans;</li>
<li>DC plans can have investment strategies tailored to the retirement preferences of the individual; and</li>
<li>Well-managed cash balance and DC accounts for retirees will have asset allocations towards safer investments that are explicitly designed to avoid getting hit by market downturns.</li>
</ul>
<p>Finally, the NIRS paper omits from their analysis a significant consideration for how DB plans might be negatively impacting local economies: as unfunded liabilities for DB plans have grown across the country, required amortization payments have been consuming more and more of state and local budgets. This growth in pension debt cost is crowding out spending on public goods and services, while also making it difficult to reduce tax rates. <em>Even if we assume that a multiplier for retiree spending could be accurately determined and that retirement benefits from DB plans are spent in a meaningfully different way than retirement income derived from other sources, any consideration of how those expenditures influence a local economy would also have to factor in the negative impacts of pension debt in that municipality.</em></p>
<p>In fact, poor historic investment returns, failure to re-allocate assets given the &ldquo;<a href="http://www.ocregister.com/articles/percent-724808-returns-pension.html">new normal</a>&rdquo; of lower projected future market returns, and troublesome funding policies such as <a href="http://reason.org/blog/show/rockefeller-volatility-vs-underfund">30-year, level-percent, &ldquo;open&rdquo; method of amortizing unfunded liabilities</a>, suggest that DB plans can have serious destabilizing effects too.</p>
<p>The Dallas Police &amp; Fire Pension System knows only too well how generous benefit formulas along with dubious funding practices can hurt the overall solvency of the DB plan, as well as the <a href="http://reason.org/blog/show/dallas-public-safety-pension-crisis">credit rating of an entire city</a>. Over the last nine years (2007-2016), the plan saw its funded status decline precipitously from 89% to 45%, while unfunded liabilities skyrocketed from $409 million to $3.3 billion. Not only did this directly crowd out an <a href="http://www.bloomberg.com/news/articles/2016-09-27/dallas-police-seeing-exodus-as-era-of-low-returns-costs-pension">anticipated $800 million bond sale</a> for infrastructure projects, but it also induced plan&rsquo;s board of trustees to request additional <a href="http://www.nytimes.com/2016/11/21/business/dealbook/dallas-pension-debt-threat-of-bankruptcy.html">$1.1 billion from city's&nbsp;taxpayers</a> to balance fund&rsquo;s liabilities, an amount that approximately equals Dallas&rsquo;s entire general fund budget. And this is just one recent example showing the limitations and challenges public DB plans face today.</p>
<p>None of this critique requires taking a position on whether DC plans or DB plans are better methods for providing retirement benefits. Instead, our argument is that rather than taking the supposed benefits of DB plans at face value, one needs to consider whether there is any meaningful difference in how DB pensions are spent relative to other retirement plan incomes and be fully aware of DB plan shortcomings. It is quite possible that the net effect of rising pension debt means DB plans are actually hurting local economies more than any supposed economic benefits they might get from retiree spending.&nbsp;</p>1014733@http://www.reason.orgMon, 12 Dec 2016 08:00:00 ESTanil.niraula@reason.org (Anil Niraula)Pension Reform Newsletter - November 2016http://www.reason.org/news/show/pension-reform-newsletter-nov16
<p>This newsletter from Reason Foundation's Pension Integrity Project highlights articles, research, opinion, and other information related to public pension challenges and reform efforts across the nation. You can find previous editions <a href="http://reason.org/newsletters/pensionreform/">here</a>.</p>
<p><strong><span style="font-size: 120%;">In This Issue:</span></strong></p>
<p><strong><a href="#a">Articles, Research &amp; Spotlights</a></strong></p>
<ul type="disc">
<li><a href="#b">CalPERS Says 7.5% Returns Over the Next Decade Unlikely</a></li>
<li><a href="#c">Baby Boomers and the New Normal</a></li>
<li><a href="#d">Federal Court Upholds Chattanooga COLA Adjustments</a></li>
<li><a href="#e">Moving Forward Despite Low Market Returns</a></li>
<li><a href="#f">Are Discount Rates and Funded Ratios Correlated?</a></li>
<li><a href="#g">Goodbye (and Good Riddance) to Kentucky's Hedge Fund Investments</a></li>
</ul>
<p><strong><a href="#i">News in Brief</a></strong></p>
<p><strong><a href="#j">Quotable Quotes on Pension Reform</a></strong></p>
<p><strong><a href="#k">Contact the Pension Reform Help Desk</a></strong></p>
<hr />
<p><a name="a"></a><strong><span style="font-size: 120%;">Articles, Research &amp; Spotlights</span></strong></p>
<p><a name="b"></a><br /><strong>CalPERS Says 7.5% Returns Over the Next Decade Unlikely</strong></p>
<p>After announcing last year a gradual 20-year reduction in its assumed rate of return, the California Public Employees Retirement System (CalPERS) is now considering bringing that rate down faster. In a recent blog post, Reason's Anthony Randazzo explains why this would be a sensible move and could portend a more widespread shift by other public pension plans nationally, given CalPERS' position as an influential market leader.<br /> <span style="font-size: 80%; color: red;">&raquo; <a href="http://reason.org/blog/show/calpers-says-75-returns-unlikely">FULL ARTICLE</a></span></p>
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<hr />
<p><a name="c"></a><br /><strong>Baby Boomers and the New Normal</strong></p>
<p>The "new normal" of low investment returns poses a challenge for many pension systems, forcing them to invest in riskier assets to meet unsustainably high investment return assumptions. Experts cite declining interest rates, slowing growth in China, political instability, and low inflation as some of the culprits. But a recent Federal Reserve study attributes almost all of the decline in GDP growth and interest rates to one factor: the aging of the baby boom generation. Reason's Daniel Takash explains in a recent blog post why, for public sector pension plans, this is yet another warning that 30-year average returns meeting current expectations is not a meaningful measure for the probability of future investment success.<br /> <span style="font-size: 80%; color: red;">&raquo; <a href="http://reason.org/blog/show/baby-boomers-new-normal">FULL ARTICLE</a></span></p>
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<hr />
<p><a name="d"></a><br /><strong>Federal Court Upholds Chattanooga COLA Adjustments</strong></p>
<p>A Sixth U.S. Circuit Court of Appeals ruling earlier this month upheld an ordinance passed by the city of Chattanooga, Tennessee in 2014 to reduce COLAs for retirees in the Chattanooga Fire and Police Pension Fund (CFPPF) until the plan is 80% funded. The court held that the CFPPF COLA was not explicitly included in the provisions of the law that outline vested benefits; thus, since it was not a vested right, the COLA provisions could be amended. While simply reducing COLA payments today in order to kick the can on meaningful, structural reforms should not be considered real pension reform, Reason's Daniel Takash writes in a recent blog post that COLA reductions&mdash;to the degree they are legally allowed and do not undermine retirement security&mdash;could be one piece of a larger pension reform package.<br /> <span style="font-size: 80%; color: red;">&raquo; <a href="http://reason.org/blog/show/chattanooga-cola-adjustments">FULL ARTICLE</a></span></p>
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<p><a name="e"></a><br /><strong>Moving Forward Despite Low Market Returns</strong></p>
<p>Despite recovery in most areas of the financial markets, pension funds have not seen their long-term averages rise to expected levels, and bleak future market outlooks suggest significantly lower returns over the next few decades relative to the last few. In a recent blog post, Reason's Anil Niraula examines a recent report by S&amp;P Global that provides a good explanation of the implications of the new investment return realities for public pension plans around the country. By looking at factors that influence pension plans' funded status, along with analysis of different approaches states have taken to address growing unfunded liabilities, the report offers some helpful insights for public plan managers on how to move forward in the market "new normal."<br /> <span style="font-size: 80%; color: red;">&raquo; <a href="http://reason.org/blog/show/moving-forward-despite-low-returns">FULL ARTICLE</a></span></p>
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<hr />
<p><a name="f"></a><br /><strong>Are Discount Rates and Funded Ratios Correlated?</strong></p>
<p>The Society of Actuaries recently published a study looking at the relationship between the funded status of defined benefit retirement systems and the discount rates they used. The report focused on the biggest public and private defined benefit plans in the U.S. between 2009 and 2014, concluding that there is no clear causal relationship between the unfunded liabilities of a plan and how the plan values its liabilities. However, public sector pension plans should not surmise from this finding that all is well with the discount rate practices they are using, as Reason's Anil Niraula and Anthony Randazzo explain in a recent blog post.<br /> <span style="font-size: 80%; color: red;">&raquo; <a href="http://reason.org/blog/show/discount-rates-and-funded-ratios">FULL ARTICLE</a></span></p>
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<hr />
<p><a name="g"></a><br /><strong>Goodbye (and Good Riddance) to Kentucky's Hedge Fund Investments</strong></p>
<p>The Kentucky Retirement System's (KRS) investment committee recently announced plans to remove hedge funds from the pension system's portfolio. If successful, this would completely eliminate hedge funds&mdash;currently about 10% of KRS's portfolio&mdash;from the retirement system's investment mix by 2019. In a recent article, Reason's Daniel Takash explains why moving out of risky assets the Commonwealth has a poor history with is a step in the right direction to address the misfortune that KRS currently faces.<br /> <span style="font-size: 80%; color: red;">&raquo; <a href="http://reason.org/news/show/goodbye-and-good-riddance-to-kentuc">FULL ARTICLE</a></span></p>
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<hr />
<p><a name="i"></a><strong><span style="font-size: 120%;">News in Brief</span></strong></p>
<p><span style="text-decoration: underline;">Arizona Supreme Court Ruling Strikes Down 2011 Pension Reforms</span>: Earlier this month, the Arizona Supreme Court upheld a lower court ruling finding some provisions of a 2011 pension reform law unconstitutional. The provisions required increased employee pension contributions and limited permanent benefit increases in various pension plans operated by the state's Public Safety Personnel Retirement System (PSPRS). The ruling is expected to create at least a $220 million hit to the system by way of employee refunds, <a href="http://www.azcentral.com/story/news/local/arizona-investigations/2016/11/14/arizona-supreme-court-ruling-public-safety-pension-trust-refunds/93805222/">according to the <em>Arizona Republic</em></a>, as well as increase unfunded liabilities in the affected pension plans.<br /><br />The ruling does not affect the <a href="http://reason.org/news/show/az-public-safety-pension-reform">2016 reforms to PSPRS</a>&mdash;which Reason's Pension Integrity Project team helped design and negotiate on behalf of state officials&mdash;that replaced the permanent benefit increase mechanism with a CPI-capped COLA, as well as created a new benefit tier with defined benefit and defined contribution options for new hires starting in July 2017. The full ruling is <a href="http://www.azcourts.gov/Portals/0/OpinionFiles/Supreme/2016/CV150180TAP.pdf">available here</a>.</p>
<p><span style="text-decoration: underline;">New Report Examines Longevity Risk for Pension Funds</span>: A new report by PGIM, Inc.&mdash;the principal asset management business of Prudential Financial, Inc.&mdash;finds that while investment and interest rate risks have been a primary focus of U.S. pension plan sponsors, steadily increasing life expectancy poses significant longevity risk problems for plans to contend with, problems exacerbated by the current ultra-low interest rate environment. The full report is <a href="https://www.pgim.com/wps/wcm/connect/1f9944a2-025a-4aa2-91bd-0b38378e7b5a/Longevity_Liabilities.pdf?MOD=AJPERES&amp;CVID=lxJbM0Q&amp;CVID=lxgflFL&amp;CVID=lxgflFL&amp;CVID=lxgflFL&amp;CVID=lxgflFL&amp;CVID=lvjvOhg&amp;CVID=loTqD.H&amp;CVID=loTqD.H&amp;CVID=loTqD.H&amp;CVID=loTqD.H&amp;CVID=loTqD.H&amp;CVID=loTqD.H&amp;CVID=loTqD.H&amp;CVID=loTqD.H&amp;CVID=loTqD.H">available here</a>.</p>
<p><span style="text-decoration: underline;">Moody's Report Finds Growing Municipal Pension Stress</span>: A recent report by Moody's Investors Service finds that unfunded pension liabilities for the top 50 local governments have more than doubled over the last decade, with nearly two-thirds of those governments now seeing pension liabilities at levels exceeding that of bonded debt. The report found that municipalities with the highest adjusted net pension liabilities as a percentage of FY 2015 operating revenue were Chicago (719%), Dallas (549%), Phoenix (434%), Houston (414%), and Los Angeles (407%). More details are <a href="https://www.moodys.com/research/Moodys-Unfunded-pension-liabilities-now-exceed-debt-for-many-large--PR_357522">available here</a>.</p>
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<hr />
<p><a name="j"></a><strong><span style="font-size: 120%;">Quotable Quotes on Pension Reform</span></strong></p>
<p>"Using actuarial sleight of hand to deny hard realities is a recipe for disaster. In the end, it's no better than trying to recoup gambling losses by doubling down on the next bet."<br /><br />&mdash;Ed Bartholomew, "<a href="http://www.milkenreview.org/articles/public-pensions-dont-look-now-but">Public Pensions: Don't Look Now, But...</a>," <em>Milken Institute Review</em>, November 1, 2016.</p>
<p><br />"It is horribly ironic that a city that has enjoyed such tremendous success, a city that has made Texas so strong and so proud is potentially walking into the fan blades that look like bankruptcy [&hellip;] Shame on me. Shame on you. Shame on all of us if we allow that to happen."<br /><br />&mdash;Dallas (TX) Mayor Mike Rawlings, presenting to the Texas Pension Review Board, cited in Stephen Young, "<a href="http://www.dallasobserver.com/news/mayor-rawlings-warns-of-fan-blades-that-look-like-bankruptcy-over-police-and-fire-pension-8873598">Mayor Rawlings Warns Of 'Fan Blades That Look Like Bankruptcy' Over Police and Fire Pension</a>,&rdquo; <em>Dallas Observer</em>, November 4, 2016.</p>
<p><br />"California's public pension and other retirement costs are at the inception of a steep rise caused by dishonest governance, reporting and funding. The consequences for citizens are enormous. To protect them, elected officials and candidates must fully understand the math."<br /><br />&mdash;David Crane, "<a href="https://medium.com/&#64;DavidGCrane/defined-benefit-plans-per-se-are-not-the-problem-37d24257cc7b#.jmnb3p8v2">Defined Benefit Plans Per Se Are Not The Problem</a>," Medium.com (blog), November 4, 2016.</p>
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<hr />
<p><a name="k"></a><strong><span style="font-size: 120%;">Contact the Pension Reform Help Desk</span></strong></p>
<p>Reason Foundation's Pension Reform Help Desk provides information and technical resources for those wishing to pursue pension reform in their states, counties and cities. Feel free to contact the Reason Pension Reform Help Desk by e-mail at <a href="mailto:pensionhelpdesk&#64;reason.org">pensionhelpdesk&#64;reason.org</a>.</p>
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<hr />
<p><em>Follow the discussion on pensions and other governmental reforms at <a href="http://www.reason.org">Reason Foundation's website</a> or on Twitter (<a href="https://twitter.com/ReasonReform?lang=en">&#64;ReasonReform</a>). As we continually strive to improve the publication, please feel free to send your questions, comments and suggestions to <a href="mailto:leonard.gilroy&#64;reason.org">leonard.gilroy&#64;reason.org</a>.</em></p>
<p>Leonard Gilroy<br />Senior Managing Director, Pension Integrity Project<br />Reason Foundation<br /><br />Anthony Randazzo<br />Managing Director, Pension Integrity Project<br />Reason Foundation</p>1014726@http://www.reason.orgWed, 30 Nov 2016 17:00:00 ESTleonard.gilroy@reason.org (Leonard Gilroy)Pension Reform Newsletter - October 2016http://www.reason.org/news/show/pension-reform-newsletter-oct16
<p>This newsletter from Reason Foundation's Pension Integrity Project highlights articles, research, opinion, and other information related to public pension challenges and reform efforts across the nation. You can find previous editions <a href="http://reason.org/newsletters/pensionreform/">here</a>.</p>
<p><strong><span style="font-size: 120%;">In This Issue:</span></strong></p>
<p><strong><a href="#a">Articles, Research &amp; Spotlights</a></strong></p>
<ul type="disc">
<li><a href="#b">Report Challenges Standard Public Pension Actuarial Practices</a></li>
<li><a href="#c">Pension Obligation Bonds Increase Risk</a></li>
<li><a href="#d">Teachers' Pensions Are Unaffordable&hellip;for Teachers</a></li>
<li><a href="#e">Dallas Bond Rating Downgraded Over Public Safety Pension Crisis</a></li>
<li><a href="#f">Houston's Pension Problems: Causes and Solutions</a></li>
<li><a href="#g">10-Year Investment Returns Update for State Pensions</a></li>
<li><a href="#h">Pension Fund Investment in Real Estate</a></li>
</ul>
<p><strong><a href="#i">News in Brief</a></strong></p>
<p><strong><a href="#j">Quotable Quotes on Pension Reform</a></strong></p>
<p><strong><a href="#k">Contact the Pension Reform Help Desk</a></strong></p>
<hr />
<p><a name="a"></a><strong><span style="font-size: 120%;">Articles, Research &amp; Spotlights</span></strong></p>
<p><a name="b"></a><br /><strong>Temporarily Blocked Paper Finally Published, Challenges Standard Actuarial Practices in Public Pensions</strong></p>
<p>The application of financial economics to pension actuarial practices has been controversial in American actuarial circles. Hence, people paid attention when the American Academy of Actuaries (AAA) and the Society of Actuaries (SOA) jointly sponsored a pension finance task force to produce a paper about applying financial economics to public pension plans. Unfortunately, the task force was not immune from the politics surrounding public plan funding policies and the joint development of the paper was abandoned and decades-long running task force was disbanded. After the groups initially said they would not release the commissioned paper, the SOA eventually changed its position and posted a "draft" of the paper on its website. Reason's Truong Bui reviews this report in a recent article and finds that it provides valuable information that challenges the standard actuarial practices in public pensions.<br /> <span style="font-size: 80%; color: red;">&raquo; <a href="http://reason.org/blog/show/report-challenges-standard-actuaria">FULL ARTICLE</a></span></p>
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<p><a name="c"></a><br /><strong>Pension Obligation Bonds Add Risk When Pension Funds Should Be Decreasing Risk</strong></p>
<p>Pension obligation bonds (POBs) are bonds issued by a state, county or municipal government specifically to finance its pension system. Oakland, California issued the first POB in 1985, trying to leverage borrowed money and make higher returns than otherwise possible using contributions alone. Higher investment returns means reduced future contributions; this is referred to as "actuarial arbitrage." However, as Reason's Daniel Takash writes, POBs are not a tool used by prudent pension funds to increase returns. Rather, they are straws that struggling funds grasp at when they're already underwater.<br /> <span style="font-size: 80%; color: red;">&raquo; <a href="http://reason.org/news/show/pension-obligation-bonds-add-risk">FULL ARTICLE</a></span><br /><span style="font-size: 80%; color: red;">&raquo; <a href="http://reason.org/blog/show/alaska-backs-down-from-pension-obli">RELATED: Alaska Backs Down from Pension Obligation Bond Issuance</a></span></p>
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<p><a name="d"></a><br /><strong>Teachers' Pensions Are Unaffordable for Teachers, Too</strong></p>
<p>A traditional conservative critique of public sector pensions usually includes some mention about how government workers, particularly teachers, are all bankrupting the system with their generous benefits. Yet, this is an overly simplistic narrative, as USC Santa Barbara's Dick Startz discusses in a two-part commentary for the Brookings Institution. As Reason's Daniel Takash writes, Startz finds that while unfunded teacher pensions are a "disaster waiting to happen for taxpayers," most pension systems actually hurt teachers too.<br /> <span style="font-size: 80%; color: red;">&raquo; <a href="http://reason.org/blog/show/pensions-unaffordable-for-teachers">FULL ARTICLE</a></span></p>
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<p><a name="e"></a><br /><strong>Fitch Downgrades Dallas Bond Rating Over City Public Safety Pension Crisis</strong></p>
<p>Fitch recently downgraded the City of Dallas (Texas) bond rating in light of the worsening public debt of its police and fire pension fund. For years, the Dallas Police &amp; Fire Pension System has seen a steady erosion of its solvency that could be attributed to poor investment management, overly optimistic actuarial assumptions, and lavish benefit payments that weren't properly pre-funded. Moreover, recent actuarial valuations suggest that time for prudent actions seems to be running out&mdash;the plan is only 45.1% funded and projected to run out of money as early as 2030 if not sooner. Meanwhile, the Deferred Retirement Option Plan&mdash;one of the most troublesome elements within this pension system&mdash;has already experienced an exodus of $220 million in withdrawals in less than six weeks. Reason's Anil Niraula explores the Dallas situation in a new article.<br /> <span style="font-size: 80%; color: red;">&raquo; <a href="http://reason.org/blog/show/dallas-public-safety-pension-crisis">FULL ARTICLE</a></span></p>
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<hr />
<p><a name="f"></a><br /><strong>Houston's Pension Problems: Causes and Solutions</strong></p>
<p>We frequently see the same pattern in troubled U.S. pension plans: poor funding policies and faulty investment return assumptions that combine to drive growth in unfunded liabilities and volatility in the pension contribution rates paid by employers/taxpayers. These very factors have plagued the financial state of Houston, Texas' public pensions; without major reforms, the city's unfunded pension liability and required contributions are expected to continue growing indefinitely. Houston Mayor Sylvester Turner recently announced a pension reform proposal that includes lowering the assumed rates of return, negotiated changes to COLA and DROP benefits, and adopting a more prudent amortization policy. Nonetheless Reason's Truong Bui writes that all of these measures are steps in the right direction, though other elements of the reform proposal are problematic. Given the size of Houston, the coming reforms&mdash;whether successful or not&mdash;can provide valuable lessons for other local and state governments.<br /> <span style="font-size: 80%; color: red;">&raquo; <a href="http://reason.org/blog/show/houstons-pension-problems-causes-an">FULL ARTICLE</a></span></p>
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<p><a name="g"></a><br /><strong>10-Year Investment Returns Update for State Pensions</strong></p>
<p>Most public sector pension funds finished their fiscal years on June 30, and reports on their 2015&ndash;16 investments are starting to trickle in. The reports thus far are showing that virtually every plan has missed its assumed rate of return for the year, in part because public plans are heavily exposed to returns on U.S. equities, which struggled between July 1, 2015 and June 30, 2016. The S&amp;P 500 index returned only 2.62% over that time span, and companies in Dow collectively produced just 3.07%. In a new article, Reason's Daniel Takash explores the effect that these kinds of returns have on the long-run investment performance of a plan.<br /> <span style="font-size: 80%; color: red;">&raquo; <a href="http://reason.org/blog/show/10-year-investment-returns-update-f">FULL ARTICLE</a></span></p>
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<p><a name="h"></a><br /><strong>Spotlight on Pension Fund Investment in Real Estate</strong></p>
<p>As public sector pension plans have sought to supplement falling yields from bonds and equities, real estate has emerged as a top choice for alternative investment. Real estate is an attractive investment because pension plans are managing funds that have long-term commitments, and real estate tends to be an asset to hold for the long term. However, pension plans also are managed several steps removed from the taxpayers that ultimately bear the responsibility for investment losses, and it's impossible to define risk tolerance for a multi-generational group of taxpayers. As Reason's Anil Niraula writes, there is a limit to the degree of diversification that a public plan should take on, and there are strong arguments for public plans heavily weighting less risky assets in their portfolios.<br /> <span style="font-size: 80%; color: red;">&raquo; <a href="http://reason.org/blog/show/spotlight-on-real-estate-investment">FULL ARTICLE</a></span></p>
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<p><a name="i"></a><strong><span style="font-size: 120%;">News in Brief</span></strong></p>
<p><span style="text-decoration: underline;">Rockefeller Institute Warns of Large Risks in Public Pension Funds</span>: A recent presentation by the Rockefeller Institute's Donald Boyd and Yimeng Yin at the National Conference of State Legislatures summit in August finds that, despite pension reforms and increased employer contributions, public pension underfunding remains at a near-record high as a percentage of state and local taxes. Further, public pension funds have increased their risk exposure over time, increasing the risk of funding shortfalls and higher taxpayer contributions. Boyd and Yin also find that for every dollar in increased state and local tax revenue between 2007 and 2015, there has been a 59-cent increase in pension contributions, leaving relatively little left for other budget priorities. The presentation is <a href="http://www.rockinst.org/pdf/government_finance/Boyd%20Yin%20NCSL%20Chicago%202016-08-10(25).pdf">available here</a>.</p>
<p><span style="text-decoration: underline;">Moody's Projects Rising State Pension Debt</span>: An analysis by Moody's Investors Service released earlier this month found that the aggregate adjusted net pension liabilities (ANPL) at the state level totaled $1.25 trillion in fiscal 2015, and is poised to rise to $1.75 trillion by fiscal 2017. The report also found that the states with the highest pension burdens, as measured by the three-year average ANPL as a share of state revenue, were Illinois (280%), Connecticut (209%), Alaska (179%), Kentucky (162%), and New Jersey (157%). More information is <a href="https://www.moodys.com/research/Moodys-US-states-FY-2015-net-pension-liabilities-reach-125--PR_356175">available here</a>.</p>
<p><span style="text-decoration: underline;">New Manhattan Institute Report Finds Rising Teacher Pension Costs and Debt</span>: A new report on teacher pensions by Manhattan Institute senior fellow Josh McGee finds that retirement costs per pupil are already approaching 10% of all education expenditures and that, absent reform, pension costs are likely to increasingly crowd out other education spending (e.g., salaries, supplies, facility maintenance, etc.), given that pension debt costs are rising faster than total annual per-student education spending. The report finds that pension debt per pupil increased by an inflation-adjusted $9,588 between 2000 and 2013, which was over nine times larger than the increase in total annual education expenditures per pupil. The full report is <a href="https://www.manhattan-institute.org/html/feeling-squeeze-pension-costs-are-crowding-out-education-spending-9368.html">available here</a>.</p>
<p><span style="text-decoration: underline;">New Milliman Public Pension Funding Study</span>: Milliman recently released its annual Public Pension Funding Study 2016 examining the funded status of the 100 largest U.S. public pension plans. The report, which recalibrates the plans' reported liabilities based on an independent assessment of expected investment returns, finds a decline in the aggregate funded ratio from 71.7% in 2015 to 69.8% in 2016, given disappointing market returns. Further, the report finds that the difference between the average sponsor-reported assumed rate of return of 7.50% and Milliman's independently determined assumption of 6.99% is the highest it has ever reported, suggesting continuing pressure on the plans to lower rate of return assumptions. The full report is <a href="http://www.milliman.com/PPFS/">here</a>.</p>
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<p><a name="j"></a><strong><span style="font-size: 120%;">Quotable Quotes on Pension Reform</span></strong></p>
<p>"There is some justice, I suppose, in the [Pennsylvania] Legislature sending Gov. Tom Wolf a bill that finally allows beer distributors to sell six-packs. It's now that much easier for the rest of us to drink away our sorrows over the Legislature's abject failure (again) to clean up their own mess and pass a bill fixing Pennsylvania's financially disastrous public employee pension system."<br /><br />&mdash;John L. Micek, "<a href="http://www.pennlive.com/opinion/2016/10/the_sound_of_a_pension_can_bei.html">The sound of a pension can being kicked ... again ... rings hollow</a>," <em>The Patriot-News</em>, October 27, 2016.</p>
<p><br />"The private-sector funding problem will, at least, diminish in the long run as old DB schemes run down. But there will be no respite for governments. They have been slow to switch workers to DC schemes, because the power of public-sector trade unions to resist lower benefits is greater than in much of the private sector. A two-tier system may emerge, with retired private-sector workers finding themselves worse off than their public-sector counterparts, but still funding those luckier workers through their taxes."<br /><br />&mdash;"<a href="http://www.economist.com/news/briefing/21707560-it-costs-lot-more-fund-modern-retirement-employers-workers-and-governments-are-not">Fade to grey</a>," <em>The Economist</em>, September 24, 2016 print edition.</p>
<p><br />"The benefits workers have already accrued and that are promised by their current contracts should be sacrosanct; the ones they have not yet earned for work they have not yet performed should be subject to limited amendment if necessary to ensure the health of the pension fund. This can serve the employees' interests too&mdash;for example, they may prefer to increase their pension contributions in order to avoid layoffs or pay freezes. Nor is anyone served when local governments go bankrupt, raising the possibility of cutting benefits for current retirees too."<br /><br />&mdash;"<a href="http://www.latimes.com/opinion/editorials/la-ed-pensions-supreme-court-20161020-snap-story.html">More flexibility over public worker pensions could help save them</a>" (editorial), <em>Los Angeles Times</em>, October 21, 2016.</p>
<p><br />"If you're counting on the stock market bailing you out of this, it ain't gonna happen."<br /><br />&mdash;Oregon PERS Executive Director Steven Rodeman on rising pension contribution rates through 2023 even under healthy investment return scenarios, quoted in Taylor Anderson, "<a href="http://www.bendbulletin.com/localstate/4679896-151/legislators-hold-their-own-pers-hearing-amid-huge">Legislators hold their own PERS hearing, amid huge projected shortfall</a>," <em>The Bulletin</em>, September 22, 2016.</p>
<p><br />"You cannot expect outsize returns in an environment with such low interest rates and with equity markets at valuations that are high relative to historical data."<br /><br />&mdash;Tom Byrne, chairman of the New Jersey State Investment Council, quoted in Samantha Marcus, "<a href="http://www.nj.com/politics/index.ssf/2016/09/njs_pension_fund_vexed_by_negative_returns_last_ye.html">N.J. pension fund lost money on investments last year</a>," NJ.com, September 29, 2016.</p>
<p><br />"There appears to be a lesson to be drawn from Wisconsin's fully funded public pension system, along with promising pension reforms recently enacted in Arizona: More risk sharing between employers and employees can be a major ingredient in creating fiscally sustainable state- and local-government retirement systems."<br /><br />&mdash;Charles Chieppo, "<a href="http://www.governing.com/blogs/bfc/col-wisconsin-arizona-public-pensions-benefits-risk-sharing.html">Risk Sharing's Key Role in Strengthening Public Pensions</a>," Governing.com, October 4, 2016.</p>
<p><br />"The recent decision by several of [Illinois' state pension] funds to lower expected rates of return to a more realistic level is reasonable, but also means that the state will have to pay even more now to stay on its funding plan [&hellip;] Staying in an actuarially sound plan is one step to limiting the cost of these plans to current and future taxpayers. Illinois needs to continue to explore all options, including a constitutional amendment clarifying that the pension protection clause applies only to accrued benefits and not future benefits."<br /><br />&mdash;Civic Federation of Chicago President Laurence Msall, quoted in Yvette Shields, "<a href="http://www.bondbuyer.com/news/regionalnews/illinois-pension-shifts-further-pressure-state-government-1114523-1.html">Illinois Pension Shifts Further Pressure State Government</a>," <em>The Bond Buyer</em>, September 23, 2016.</p>
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<p><a name="k"></a><strong><span style="font-size: 120%;">Contact the Pension Reform Help Desk</span></strong></p>
<p>Reason Foundation's Pension Reform Help Desk provides information and technical resources for those wishing to pursue pension reform in their states, counties and cities. Feel free to contact the Reason Pension Reform Help Desk by e-mail at <a href="mailto:pensionhelpdesk&#64;reason.org">pensionhelpdesk&#64;reason.org</a>.</p>
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<p><em>Follow the discussion on pensions and other governmental reforms at <a href="http://www.reason.org">Reason Foundation's website</a> or on Twitter (<a href="https://twitter.com/ReasonReform?lang=en">&#64;ReasonReform</a>). As we continually strive to improve the publication, please feel free to send your questions, comments and suggestions to <a href="mailto:leonard.gilroy&#64;reason.org">leonard.gilroy&#64;reason.org</a>.</em></p>
<p>Leonard Gilroy<br />Senior Managing Director, Pension Integrity Project<br />Reason Foundation<br /><br />Anthony Randazzo<br />Managing Director, Pension Integrity Project<br />Reason Foundation</p>1014691@http://www.reason.orgFri, 28 Oct 2016 12:00:00 EDTleonard.gilroy@reason.org (Leonard Gilroy)Americas Debt and Deficithttp://www.reason.org/news/show/americas-debt-and-deficit
<p><strong>Executive Summary</strong></p>
<p>Claims of victory from the Obama administration aside, federal debts and deficits remain a serious problem. In 2015, the annual deficit reached a low of 2.5% of GDP, which is much worse than previous cyclical troughs achieved in 2000 and 2007. Even more troublesome, the Congressional Budget Office projects that deficits will steadily increase in the coming decades as Baby Boomers continue to retire and health care costs rise. The major party presidential candidates have not offered meaningful proposals to address this issue, as they focus on personal attacks, immigration, trade and other matters. Libertarian Gary Johnson appears to have the best overall approach to the deficit, but even his policies need to be more completely fleshed out.</p>
<p>&nbsp; &nbsp;&nbsp;<span style="color: #ffffff;">.</span>&nbsp;</p>
<p><strong>Written by: Marc Joffe</strong><br /><strong>Project Director: Anthony Randazzo</strong></p>
<h4><strong>Part 1: The Deficit Problem and Its Causes</strong></h4>
<h5>Introduction</h5>
<p>U.S. federal government debt as a percentage of Gross Domestic Product (GDP) is at its highest level since World War II. Unless significant changes are made to entitlement programs, which together with other &ldquo;mandatory&rdquo; spending represent 68% of the federal budget, it is likely to increase in coming decades. The Congressional Budget Office (CBO) projects that within 30 years, interest on the debt alone will account for over 20% of the federal budget.<a href="#_ftn1" name="_ftnref1">[1]</a></p>
<p>Evidence <a href="http://www.nytimes.com/2013/04/26/opinion/debt-growth-and-the-austerity-debate.html">suggests</a> that high levels of government debt can reduce economic growth. Given the pernicious nature of this problem, one might imagine that it would be a major issue for presidential candidates. Yet it is receiving less attention from the public and from major party presidential candidates during this cycle than it did in 2012. Before the 2012 election, 12% of respondents <a href="http://www.gallup.com/poll/158267/economy-dominant-issue-americans-election-nears.aspx">told Gallup</a> that the federal budget was the nation&rsquo;s most pressing problem. By May 2016, <a href="http://www.gallup.com/poll/191513/economy-continues-rank-top-problem.aspx">that number</a> had declined to 3%. Hillary Clinton doesn&rsquo;t even have a page addressing the deficit on her website, while Donald Trump&rsquo;s site contains a video that only discusses the nation&rsquo;s debt in a very general way. This brief seeks to outline the scale of the problem of debt and deficits tied to federal spending and describe the approach to the problem taken by the various presidential candidates.</p>
<h5><strong>1.1 The Federal Deficit is Growing as a Percentage of GDP</strong></h5>
<p>The U.S. Treasury Department <a href="https://www.fiscal.treasury.gov/fsreports/rpt/mthTreasStmt/mts0916.pdf">reports</a> that the federal deficit for fiscal year 2016, which ended on September 30, was $587 billion, or 3.2% of GDP. Since this level compares quite favorably to the $1,413 billion (9.8% of GDP) deficit recorded at the beginning of the Obama administration in 2009, <a href="http://www.msnbc.com/rachel-maddow-show/deficit-shrinks-1-trillion-obama-era">some have claimed</a> that there is no need for concern.</p>
<p>But looking at deficit trends across business cycles, the picture becomes considerably darker. Deficits tend to peak during a recession and then fall as the economy grows, reaching a trough several years after the end of the recession. The most recent cyclical trough occurred in 2015, with a deficit of $438 billion, or 2.5% of GDP. This is considerably worse than the cyclical troughs in 2007, when the deficit was 1.1% of GDP, and 2000, when there was a <em>surplus</em> of 2.3% of GDP. The CBO expects year&rsquo;s deficit to be higher than that of 2015, suggesting that the U.S. is entering a phase of rising deficits once again.</p>
<p>The dismal picture painted by the CBO&rsquo;s forecast is shown in Figure 1. Note that without any substantive fiscal policy change the CBO estimates the deficit will continue to expand as a percentage of GDP.</p>
<p><strong>Figure 1:</strong></p>
<p><a href="/files/debtbrief/Figure1.png" target="_blank"><strong><img src="/files/debtbrief/Figure1.png" alt="" width="2253" height="902" /></strong></a></p>
<p><strong>1.2 How Federal Spending Breaks Down</strong></p>
<p>A large part of the problem of U.S. federal deficit and debt is caused by the fact that much of the federal budget is either on auto-pilot or considered sacrosanct by one of the two major parties. Three currently politically untouchable categories&mdash;Social Security, Medicare and interest on the debt&mdash;account for 47.7% of this year&rsquo;s budget. In 10 years, the CBO expects these three items to take up 58.7% of federal spending.</p>
<p>Using a wider measure of &ldquo;off-limits&rdquo; spending categories, we can reach much higher proportions of spending immune to conventional budget cutting. The CBO divides federal spending into two broad categories: mandatory and discretionary.</p>
<p>To get a sense of the scope of how concentrated federal spending is on these off-limits categories, <a href="https://public.tableau.com/views/2016FederalSpendingbyMajorCategory/FederalSpendingFY2016?:embed=y&amp;:display_count=yes">Figure 2 visually breaks out</a>&nbsp;the percentage of total spending represented by different policy priorities.</p>
<p><strong><em>Mandatory spending</em></strong> consists of all categories that are not part of the appropriation process. These types of spending continue in the absence of a budget, following pre-specified formulas unless Congress and the president change them. Aside from Medicare, Social Security and interest on the debt, mandatory spending includes unemployment insurance, earned income tax credits and Medicaid. Although some Republicans might wish to cut these programs, they enjoy widespread Democratic support.</p>
<p>The opposite is true of the largest category of <strong><em>discretionary spending</em></strong>: the defense budget. This comprises 51.8% of discretionary spending and 15.1% of all federal spending. Republicans generally oppose major reductions to the defense budget. A closely related and even more sacrosanct spending category is veterans&rsquo; programs, some of which are mandatory and some of which are discretionary.</p>
<p>Mandatory, defense and veterans spending accounts for 86.2% of this year&rsquo;s budget. The CBO expects that proportion to rise to 90.4% in 2026. Within the relatively small sliver of discretionary spending that remains are many popular programs that would also be hard to cut. The space program, for example, which costs $18.8 billion, or about 0.5% of all federal spending.</p>
<p><strong> Figure 2:</strong></p>
<div id="viz1476918183026" class="tableauPlaceholder" style="position: relative;"><noscript><a href='#'><img alt='U.S. Federal Spending by Category, 2016 ' src='https://public.tableau.com/static/images/20/2016FederalSpendingbyMajorCategory/FederalSpendingFY2016/1_rss.png' style='border: none' /></a></noscript></div>
<script>// <![CDATA[
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// ]]></script>
<h5><strong>1.3 Baby Boomer Retirements Mean Increasing Federal Expenses</strong></h5>
<p>From a demographic standpoint, federal finances are heavily impacted by the aging of the Baby Boomers. This is the generation born between 1946 and 1964, a period during which birth rates were especially high. In 2000, when the federal surplus peaked, most Boomers were <a href="https://www.newyorkfed.org/medialibrary/media/research/staff_reports/sr710.pdf">in or near their peak earning years</a>, paying relatively high marginal tax rates and generally not drawing government benefits. By 2015, many Boomers were eligible for Medicare and collecting Social Security checks.</p>
<p>The Baby Boomer retirement trend will continue through the next decade, and is expected to worsen the federal fiscal balance. In 2031, the last Boomers will reach 67, the age of eligibility for full social security benefits. By then, the CBO expects the annual deficit to reach 6.1% of GDP.</p>
<p>The pressure Baby Boomer retirements place on the federal budget comes from two sources. First, the flow of contributions into the Social Security Trust Fund will continue to decline relative to benefits paid out. Figure 3 shows the declining ratio of workers to retired Social Security beneficiaries. Before Boomers began retiring in 2008, there were 3.3 workers per retiree. By 2030, the ratio is expected to fall to 2.3.</p>
<p><strong>Figure 3:</strong></p>
<p><a href="/files/debtbrief/Figure3.png" target="_blank"><img src="/files/debtbrief/Figure3.png" alt="" width="2253" height="902" /></a></p>
<p>Second, the increase in Boomer retirements means increased pressure on Medicare. In the 1990s and early 2000s, annual enrollment increases in Medicare&rsquo;s hospital insurance program were routinely below one million. Since 2008, the annual enrollment increase has ranged between 1.1 million and 1.9 million, and is expected to continue in that range for the next several years, as shown in Figure 4.</p>
<p><strong>Figure 4:</strong></p>
<p><a href="/files/debtbrief/Figure4.png" target="_blank"><img src="/files/debtbrief/Figure4.png" alt="" width="2253" height="902" /></a></p>
<h5><strong>1.4 Increased Life Expectancy Likely Means Medical Cost Inflation</strong></h5>
<p>The CBO <a href="https://www.ssa.gov/oact/progdata/nra.html">projects</a> widening federal deficits even as the Boomers pass away, with the red ink forecast to reach 8.8% of GDP by 2046. This is partially attributable to increased life expectancy. Between 2002 and 2027, the full Social Security normal retirement age is rising from 65 to 67. This increase roughly mirrors the increase in life expectancy of individuals entering retirement: in the 25-year period ending 2014, life expectancy at age 65 rose from <a href="http://www.cdc.gov/nchs/data/hus/2011/022.pdf">17.1 years</a> to <a href="http://www.cdc.gov/nchs/data/databriefs/db244.pdf">19.3 years</a>.</p>
<p>The CBO projects a further increase in life expectancy at age 65 to 20.2 years in 2027 and 21.6 years in 2046, but no further changes in retirement age are planned. The increase in Social Security normal retirement age was legislated as part of a bipartisan plan to strengthen the program in 1983. But proposals for similar reforms, like those offered by the <a href="http://momentoftruthproject.org/sites/default/files/TheMomentofTruth12_1_2010.pdf">Simpson Bowles Commission</a>, have failed to gain traction in recent years. As a result, Social Security beneficiaries will receive checks for longer periods of time. The ratio of Social Security beneficiaries to those paying FICA taxes will continue to rise, rendering the program unsustainable.</p>
<p>This is also true of Medicare, whose eligibility age has remained at 65 since the program&rsquo;s inception. According to the Medicare Trustee&rsquo;s report, Medicare enrollment increased from 39.7 million (or 14.1% of the U.S. population) in 2000 to 55.3 million (or 17.2% of the U.S. population) in 2015. By 2030, <a href="https://www.cms.gov/Research-Statistics-Data-and-Systems/Statistics-Trends-and-Reports/ReportsTrustFunds/Downloads/TR2016.pdf">the Trustees project</a> that enrollment will grow to 81.2 million, or 22.3% of the nation&rsquo;s population.</p>
<p>Medicare (and other federal health care entitlements) are also affected by the increasing cost of health care. Between 2000 and 2015, annual medical price inflation <a href="http://data.bls.gov/cgi-bin/surveymost?cu">has exceeded</a> general price inflation by an average of 1.5%. During this period, health care spending <a href="https://www.cms.gov/Research-Statistics-Data-and-Systems/Statistics-Trends-and-Reports/NationalHealthExpendData/Downloads/NHE60-25.zip">grew</a> from 13.3% to an estimated 17.7% of GDP. Rising medical costs are <a href="https://www.zanebenefits.com/blog/seven-reasons-for-rising-health-care-costs">the result of a number of factors</a>, including the introduction of new, more expensive drugs and other technologies, and reduced competition as hospital groups and other providers continue to merge.</p>
<p>The federal budget is increasingly exposed to medical cost inflation because of both population aging and the federal government&rsquo;s greater role in health care provision. The 2010 Affordable Care Act is just the most recent expansion of federal health care responsibility. The fact that a Republican Congress established the Children&rsquo;s Health Insurance Plan in 1997 and President George W. Bush added prescription drug coverage to Medicare in 2003 shows that federal health initiatives have had bipartisan support. As a result of these changes, health care entitlements now represent over 26% of federal spending.</p>
<h5><strong>1.5 High Deficits Have Meant Increasing Debt Payments</strong></h5>
<p>Years of deficits under both the Bush and Obama administrations have driven up the nation&rsquo;s debt. But while there is widespread awareness that the national debt has gone up, headline debt numbers do not completely capture the degree to which the federal government is under water and unable to meet the many commitments it has made.</p>
<p>As of June 30, 2016 the national debt totaled $19.51 trillion or 106% of GDP. Much of the federal debt is held by federal agencies. The largest governmental holders of Treasury debt are the Social Security and Medicare trust funds ($3.08 trillion), the federal Civil Service Retirement and Disability Fund ($0.84 trillion) and the Military Retirement Fund ($0.60 trillion).</p>
<p>Government debt heldoutside the government, known as Public Debt, was $14.10 trillion, or 76% of GDP. The Public-Debt-to-GDP ratio has risen sharply since the beginning of the Bush administration when it was only 31%. The CBO&rsquo;s long-term outlook, shown in Figure 5, projects this ratio widening from today&rsquo;s 76% to 141% by 2046, eclipsing the previous peak of 106% reached at the end of World War II.</p>
<p><strong>Figure 5:</strong></p>
<p><a href="/files/debtbrief/Figure5.png" target="_blank"><img src="/files/debtbrief/Figure5.png" alt="" width="2251" height="901" /></a></p>
<p>In an environment of persistent deficits, the trend toward increasing federal debt is self-reinforcing because Treasury bonds earn interest. For any given rate of interest, the more government bonds the public holds, the more interest the government must pay. Even though interest rates are at historic lows today, the federal government will nonetheless pay $250 billion in interest, accounting for 6.5% of total spending, as shown in Figure 6. The CBO expects this number to rise sharply in upcoming years as the stock of debt increases and interest rates converge toward historical medians.</p>
<p><strong>Figure 6:</strong></p>
<p><strong><a href="/files/debtbrief/Figure6.png" target="_blank"><img src="/files/debtbrief/Figure6.png" alt="" width="2251" height="901" /></a>&nbsp;</strong></p>
<h5><strong>1.6 Total Federal Obligations Are Much Larger than Reported</strong></h5>
<p>The debt-to-GDP ratios discussed here understate the size of the government&rsquo;s indebtedness because they exclude unfunded pension and retirement benefit liabilities. Put another way, the federal government has both <em>explicit</em> debt (held by the public) as well as <em>implicit</em> debt (unfunded commitments).</p>
<p>U.S. state and local governments must report these implicit, unfunded commitments on their balance sheets under governmental accounting standards. On its balance sheet, the federal government <a href="https://www.fiscal.treasury.gov/fsreports/rpt/finrep/fr/15frusg/02242016_FR(Final).pdf">recognizes</a> $6.72 trillion of pension and benefit liabilities owed to federal civilian employees and veterans&mdash;though this is not counted toward the &ldquo;official&rdquo; federal debt that is held by the public in the form of bonds.</p>
<p>The federal financial statements also show Social Security and Medicare liabilities as &ldquo;off balance sheet items&rdquo; in separate Statements of Social Insurance. In 2015, these obligations totaled $41.38 trillion&mdash;dwarfing the $3.08 trillion in Treasury securities held by the social insurance trust funds. Another $0.11 trillion was owed to railroad retirees. Again, all of this is implicit debt, not reflected in the debt held by the public figures.</p>
<p>Finally, the federal balance sheet includes a number of other significant liabilities such as those incurred by the Pension Benefit Guaranty Corporation (PBGC), which insures payments to retirees in private sector pension systems.</p>
<p>Figure 7 shows reported federal liabilities, both on and off the balance sheet. These obligations total $62.96 trillion. After considering the federal government&rsquo;s financial assets of $3.23 trillion, that leaves a negative net position of $59.73 trillion&mdash;more than triple the nation&rsquo;s gross domestic product.</p>
<p>Some private estimates of the government&rsquo;s overall fiscal position paint an even bleaker picture. For example, Lawrence Kotlikoff and Adam Michel <a href="http://mercatus.org/sites/default/files/Kotlikoff-Closing-Fiscal-Gap.pdf">have estimated</a> that the federal government faces an overall fiscal gap of $210 trillion. This fiscal gap reflects the present value of all projected revenues and expenditures over an infinite time horizon.</p>
<p><strong>Figure 7:</strong></p>
<p><a href="/files/debtbrief/Figure7.png"><strong><img src="/files/debtbrief/Figure7.png" alt="" width="1358" height="901" /></strong></a></p>
<h4><strong>Part 2: Addressing the Problem and Evaluating the Candidates&rsquo; Plans</strong></h4>
<h5><strong>2.1 A Libertarian Approach to Fiscal Sustainability</strong></h5>
<p>The federal debt could be accomplished by increasing tax revenue, cutting aggregate spending, or some combination of the two. Libertarians generally oppose tax increases because they are coercive; they also tend to reduce economic growth.</p>
<p>Paradoxically, revenue could be increased through tax <em>cuts</em>. Reducing the corporate tax rate, for example, would boost revenue by encouraging businesses to repatriate more of the income they earn overseas, as well as by increasing investment, which would generate higher rates of economic growth. The Tax Foundation <a href="http://taxfoundation.org/blog/cut-corporate-tax-rate-would-provide-significant-boost-economy">estimates</a> that cutting the corporate tax rate to between 10% and 15% might increase net revenue by 0.2% to 0.3%.</p>
<p>However, tax cuts alone are not likely to significantly affect deficits. To cut deficits it will be necessary to cut spending. One important change would be to raise the eligibility age for Social Security, Social Security Disability Insurance, and Medicare and index them to life expectancy. In addition, these programs should be subject to more robust and sound <a href="http://www.nationalaffairs.com/publications/detail/means-testing-and-its-limits">means testing</a>; to avoid perverse incentives and outcomes, the test could be based on lifetime earnings. Medicaid should be converted to a block grant program, as recently proposed by <a href="http://budget.house.gov/fy2017/">House Republicans</a>. And individuals should be incentivized to switch to a system of low-fee personalized retirement savings accounts, which eventually should replace the Social Security program all together. The collective goal of these changes would be to replace, over time, existing open-ended entitlements with programs that have lower and less volatile liabilities.</p>
<p>Spending cuts don&rsquo;t have to solely appeal to the political right, however. Defense spending could be cut by about 50% <a href="https://reason.com/archives/2012/09/17/ready-to-cut-military-spending/">without substantially affecting national security</a>; in some cases, cuts&mdash;such as the closure of U.S. bases on foreign soil&mdash;would likely improve national security. And corporate tax expenditures and subsidies, which amount to &ldquo;corporate welfare,&rdquo; should be terminated.</p>
<p>Finally, although domestic discretionary spending is a relatively small component of overall spending, it still contains numerous opportunities for savings. Federal departments without clear, constitutionally enumerated powers&mdash;such as the Departments of Education, Energy, and Housing and Urban Development&mdash;should be closed, with their functions passed to the states or private organizations. Ending the war on drugs <a href="http://www.cato.org/publications/white-paper/budgetary-impact-ending-drug-prohibition">would reduce</a> unnecessary expenditures on enforcement and incarceration, while eliminating the economic harm done by this assault on individual liberty. Other discretionary spending can also be cut through the rigorous implementation of zero-based budgeting, a technique under which all programs are reviewed regularly and eliminated if they are found to be outmoded or ineffective.</p>
<h5><strong>2.2 Proposals from the Presidential Candidates</strong></h5>
<p>So, how do the presidential candidates propose to address the nation&rsquo;s fiscal problems, and how do they compare to the ideal outlined?</p>
<p>The Issues page of <strong>Hillary Clinton&rsquo;s</strong> campaign website does not list the debt or deficits among the topics on which she has a position. Her site does address <a href="https://www.hillaryclinton.com/issues/social-security-and-medicare/">Social Security and Medicare</a>. Clinton proposes to increase Social Security survivor benefits and to give earnings credit to those who took time out of the workforce to take care of children, parents or other relatives. She proposes to offset these extra expenditures by increasing the earnings cap to which Social Security taxes are applied and taxing unearned income. The site does not provide sufficient detail to allow the cost of additional benefits or the revenue from new taxes to be estimated.</p>
<p>With respect to Medicare, Clinton offers <a href="https://www.hillaryclinton.com/briefing/factsheets/2015/09/21/hillary-clinton-plan-for-lowering-prescription-drug-costs/">specific proposals</a> for reducing prescription costs including allowing Americans to import drugs from abroad, expediting FDA approval of lower-cost generic and biosimilar drugs, and allowing Medicare to negotiate drug prices. These reforms might cut spending a little, but the effect on the overall budget would be limited by the relatively <a href="http://www.cdc.gov/nchs/fastats/health-expenditures.htm">low proportion</a> of health spending represented by prescription drugs (9.8% of total health spending in 2014).</p>
<p>With respect to other areas of the budget, Clinton calls for increased spending on <a href="https://www.hillaryclinton.com/briefing/factsheets/2015/11/30/clinton-infrastructure-plan-builds-tomorrows-economy-today/">infrastructure</a>, <a href="https://www.hillaryclinton.com/briefing/factsheets/2016/07/06/hillary-clintons-commitment-a-debt-free-future-for-americas-graduates/">aid for college students</a>, <a href="https://www.hillaryclinton.com/issues/paid-leave/">paid family leave</a>, <a href="https://www.hillaryclinton.com/briefing/factsheets/2015/06/14/fact-sheet-universal-preschool/">universal pre-school</a>, <a href="https://www.hillaryclinton.com/briefing/factsheets/2015/12/22/an-end-to-alzheimers-disease/">Alzheimer&rsquo;s research</a>, and other priorities. The Center for a Responsible Federal Budget (CRFB) <a href="http://www.crfb.org/sites/default/files/CRFB_Promises_and_Price_Tags.pdf">estimates</a> that these new initiatives will cost between $1.40 trillion and $2.55 trillion over 10 years.</p>
<p>Clinton <a href="https://www.hillaryclinton.com/briefing/factsheets/2016/01/12/investing-in-america-by-restoring-basic-fairness-to-our-tax-code/.">proposes</a> to offset these new expenditures by raising taxes on high-income individuals and <a href="https://www.hillaryclinton.com/feed/corporate-giants-found-way-exploit-tax-loopholes-hillary-clinton-has-plan-stop-them/">preventing corporate inversions</a> (in which a U.S. entity avoids corporate income tax by being acquired by a foreign company). CRFB estimates that her tax proposals would increase revenue between $0.90 trillion and $1.60 trillion over 10 years. When the effects of her health care policy and immigration proposals are included, CRFB estimates the 10-year impact of the candidate&rsquo;s policies to be between a deficit reduction of $0.15 trillion and an increase of $2.20 trillion.</p>
<p><strong>Donald Trump&rsquo;s</strong> website contains a short video focusing on the debt and its unfairness to young people. His <a href="https://youtu.be/97iL5er3Mkc">proposed</a> solution is to stimulate the economy by lowering tax rates. Trump&rsquo;s <a href="https://www.donaldjdrumpf.com/positions/tax-reform">original tax plan</a> called for exempting low earners from the tax rolls, reducing marginal tax rates, and limiting certain deductions. A Tax Foundation analysis <a href="http://taxfoundation.org/article/details-and-analysis-donald-trump-s-tax-plan">found</a> that Trump&rsquo;s initial plan would spur economic growth, but that the added economic activity would not be sufficient to offset the revenue losses stemming from the proposal&rsquo;s lower rates. It <a href="http://taxfoundation.org/article/details-and-analysis-donald-trump-s-tax-plan">estimates</a> that the plan, if implemented, would reduce federal revenues by $10.1 trillion over 10 years and add substantial interest costs. (Trump <a href="http://taxfoundation.org/article/details-and-analysis-donald-trump-tax-reform-plan-september-2016">offered</a> a less ambitious tax plan in September 2016; the Tax Foundation has estimated that it will reduce revenues by about $3.3 trillion over 10 years.)</p>
<p>On the expenditure side, Trump&rsquo;s proposals are difficult to assess. However, <a href="http://www.wtvm.com/story/31343747/donald-trump-rallies-in-valdosta">he has ruled out</a> changes in Social Security and has not offered a plan to reform Medicare, which will make it difficult for him to achieve large savings.CRFB estimates that the overall impact of Trump&rsquo;s revenue and expenditure policies would increase the deficit over ten years by between $9.70 trillion and $16.30 trillion.</p>
<p>Green Party candidate <strong>Jill Stein</strong> <a href="http://www.jill2016.com/platform">does not specifically address</a> the deficit and debt on her website, although she does call for a 50% reduction in the defense budget and full disclosure of corporate subsidies in the federal budget. She would also increase the progressivity of the tax code and impose a carbon tax, but would also institute a costly Medicare for All entitlement and free universal child care.</p>
<p>Libertarian <strong>Gary Johnson&rsquo;s</strong> website <a href="https://www.johnsonweld.com/wasteful_spending">identifies the national debt as a major issue</a> and proposes to submit a balanced budget to Congress as his first major act in office. The site does not list specific spending cuts that Johnson would make. There is also no discussion of entitlement reform on Johnson&rsquo;s website, but the candidate has <a href="http://www.ontheissues.org/2012/Gary_Johnson_Social_Security.htm">previously called</a> for raising the retirement age. In 2016, he has called for <a href="https://www.johnsonweld.com/education">eliminating the Department of Education</a> and <a href="https://www.johnsonweld.com/foreign_policy_and_national_defense">avoiding overseas conflicts</a>.</p>
<p>Although Johnson is short on specifics, his overall direction is closest to our own. Clinton and Stein don&rsquo;t directly address the deficit, while Trump&nbsp;relies on dubious estimations of the dynamic effects of tax cuts to achieve deficit reduction.</p>
<p>&nbsp;</p>
<h4><strong>Part 3: Conclusion</strong></h4>
<p>Recent cyclical improvements in the deficit notwithstanding, the federal government continues on an unsustainable fiscal trajectory. Unsustainable trends eventually must end, and this one is most likely to end in some form of fiscal crisis unless fundamental reforms are implemented.</p>
<p>While the two major party candidates have not offered workable solutions to this problem, Gary Johnson is pointing in the right direction&mdash;although more specificity is needed. The very detailed House Republican plan has some useful ideas, but it is unlikely that there will be a complete termination of Affordable Care Act spending as their proposal suggests. Aside from controlling Social Security, Medicaid and Medicare costs, a balanced plan would also have to include indexing the retirement age to longevity, right-sizing the nation&rsquo;s military and applying zero-based budgeting to domestic programs.</p>
<p>&nbsp;&nbsp; &nbsp;&nbsp;<span style="color: #ffffff;">.</span>&nbsp;</p>
<p><strong>About the Author</strong></p>
<p>Marc D. Joffe founded Public Sector Credit Solutions in 2011 to educate the public about government debt. Before founding PSCS, Marc was a Senior Director at Moody&rsquo;s Analytics. He has an MBA from New York University and an MPA from San Francisco State University.</p>
<p>&nbsp;&nbsp; &nbsp;&nbsp;<span style="color: #ffffff;">.</span>&nbsp;</p>
<p><strong>Footnote</strong>&nbsp;</p>
<p><a href="#_ftnref1" name="_ftn1">[1]</a> This study relies heavily on CBO data available at <a href="https://www.cbo.gov/about/products/budget_economic_data">https://www.cbo.gov/about/products/budget_economic_data</a>.</p>1014680@http://www.reason.orgWed, 19 Oct 2016 18:23:00 EDTmarc.joffe@reason.org (Marc Joffe)Pension Reform Newsletter - September 2016http://www.reason.org/news/show/pension-reform-newsletter-sep16
<p>This newsletter from Reason Foundation's Pension Integrity Project highlights articles, research, opinion, and other information related to public pension challenges and reform efforts across the nation. You can find previous editions <a href="http://reason.org/newsletters/pensionreform/">here</a>.</p>
<p><strong><span style="font-size: 120%;">In This Issue:</span></strong></p>
<p><strong><a href="#a">Articles, Research &amp; Spotlights</a></strong></p>
<ul type="disc">
<li><a href="#b">Michigan Pension Reform Case Study</a></li>
<li><a href="#c">How Flexible Is the California Rule?</a></li>
<li><a href="#d">Another Tool to Measure Pension Health: Net Amortization</a></li>
<li><a href="#e">Positivity on Bad Pension Investment Returns?</a></li>
<li><a href="#f">Ranking of State Finances Offers Insight on Public Pension Debt</a></li>
<li><a href="#g">Contribution Rate Volatility vs. Long-Term Pension Underfunding</a></li>
<li><a href="#h">Could Buffered Index Funds Help Struggling Public Pensions?</a></li>
<li><a href="#i">Glossary of Pension Terminology</a></li>
</ul>
<p><strong><a href="#j">Quotable Quotes on Pension Reform</a></strong></p>
<p><strong><a href="#k">Contact the Pension Reform Help Desk</a></strong></p>
<hr />
<p><a name="a"></a><strong><span style="font-size: 120%;">Articles, Research &amp; Spotlights</span></strong></p>
<p><a name="b"></a><br /><strong>Michigan Pension Reform Case Study</strong></p>
<p>In 1996, the Michigan State Legislature passed a first-of-its-kind bill that closed the state employees' defined benefit pension fund to new members and created a defined contribution retirement plan for future hires. A new report by Reason's Anthony Randazzo finds that the legacy retirement system is more solvent today than if the legislature had not closed the defined benefit plan for new hires, with a full system funded ratio of 88% as of 2015, compared to an estimated 68% funded ratio without reform. However, while closing the defined benefit plan has prevented the state from taking on even more unfunded liabilities than without a change, the report finds that the positive effects of pension reform have been muted by the failure of policymakers to properly manage the defined benefit plan well as it is being closed over time. <br /> <span style="font-size: 80%; color: red;">&raquo; <a href="http://reason.org/studies/show/pension-reform-case-study-michigan">FULL REPORT</a></span></p>
<p><span style="font-size: 80%;">&raquo; <a href="#top">return to top</a></span></p>
<hr />
<p><a name="c"></a><strong>How Flexible Is the California Rule?</strong></p>
<p>California is notorious for having the "California Rule," a constitutional doctrine that is highly protective&mdash;some would say overprotective&mdash;of public-employee pensions and that has stymied public-employee pension reform for over half a century. Seeking at least some relief from rising pension costs, the California Legislature passed a statute in 2013 limiting the practice of "pension spiking," by which government bodies allow public employees to artificially inflate their ending compensation in order to increase those employees' pensions. This statute was recently upheld in an August 2016 appellate court ruling.<br /><br />As Emory Law School Associate Professor Alexander Volokh writes in a new reason.org article, if the California Supreme Court upholds this decision, it could ease the state's pension woes to a certain extent. But the Court of Appeals' reasoning is questionable and rests on a strained reading of past California cases, according to Volokh. Thus, it wouldn't be surprising if the Supreme Court eventually reversed this decision.<br /> <span style="font-size: 80%; color: red;">&raquo; <a href="http://reason.org/news/show/california-rule-pension-spiking">FULL ARTICLE</a></span></p>
<p><span style="font-size: 80%;">&raquo; <a href="#top">return to top</a></span></p>
<hr />
<p><a name="d"></a><strong>Another Tool to Measure Pension Health: Net Amortization</strong></p>
<p>One major reason why public sector pension plans' unfunded liabilities have grown over the past decade is that actuarially calculated amortization payments are oftentimes less than needed to fully fund benefit payments. For example, a plan with a three-decade long, open amortization schedule is almost certainly making unfunded liability amortization payments that are less than the interest accruing on that same unfunded liability, leading to negative amortization. Highlighting such concerns can often require a detailed examination of a pension plan's actuarial valuation, and as Reason's Anil Niraula and Anthony Randazzo point out, a new project by The Pew Charitable Trusts is seeking to make it a bit easier to spot the troubled plans.<br /> <span style="font-size: 80%; color: red;">&raquo; <a href="http://reason.org/blog/show/new-tool-net-amortization">FULL ARTICLE</a></span></p>
<p><span style="font-size: 80%;">&raquo; <a href="#top">return to top</a></span></p>
<hr />
<p><a name="e"></a><strong>Positivity on Bad Pension Investment Returns?</strong></p>
<p>Most pension plans with fiscal years ending June 30, 2016 have released their fiscal year investment return figures, and most have hovered around zero, with some posting modest returns of a few percentage points, and a few others trending into negative territory. Since pension plans typically have long-term investment return assumptions of between 7% and 8%, these figures mark a second straight bad year and will mean increases in the recognized value of unfunded liabilities for most plans. However, as Reason's Anthony Randazzo's recent article indicates, there has been more than once instance of real positivity from plan administrators who have managed to get returns north of 0%. Randazzo writes that just getting positive returns is a meaningless benchmark; what really matters is the number of years they've returned above or below their long-term investment return assumptions.<br /> <span style="font-size: 80%; color: red;">&raquo; <a href="http://reason.org/news/show/only-pension-streak-that-matters">FULL ARTICLE</a></span></p>
<p><span style="font-size: 80%;">&raquo; <a href="#top">return to top</a></span></p>
<hr />
<p><a name="f"></a><strong>Ranking of State Finances Offers Insight on Public Pension Debt</strong></p>
<p>A recent Mercatus Center study ranks the 50 states by fiscal condition based on a comprehensive assessment of 14 financial metrics linked to five criteria: cash solvency, budget solvency, long-run solvency, service-level solvency, and trust fund solvency. According to Reason's Truong Bui, the Mercatus fiscal condition ranking provides a valuable benchmark to evaluate states' fiscal health, which concerns not only conventional government debts but also often-overlooked pension and OPEB liabilities.<br /> <span style="font-size: 80%; color: red;">&raquo; <a href="http://reason.org/blog/show/ranking-of-state-finances-offers-in">FULL ARTICLE</a></span></p>
<p><span style="font-size: 80%;">&raquo; <a href="#top">return to top</a></span></p>
<hr />
<p><a name="g"></a><strong>Contribution Rate Volatility vs. Long-Term Pension Underfunding</strong></p>
<p>In a new blog post, Reason's Anil Niraula reviews a recent Rockefeller Institute simulation project that found that while common funding policies and practices of public sector retirement systems are effective at reducing year-to-year contribution rate volatility, there is a troublesome flip side to the equation: common funding policies are also increasing the likelihood of severe long-term underfunding.<br /> <span style="font-size: 80%; color: red;">&raquo; <a href="http://reason.org/blog/show/rockefeller-volatility-vs-underfund">FULL BLOG POST</a></span></p>
<p><span style="font-size: 80%;">&raquo; <a href="#top">return to top</a></span></p>
<hr />
<p><a name="h"></a><strong>Could Buffered Index Funds Help Struggling Public Pensions?</strong></p>
<p>In a new blog post, Reason's Daniel Takash examines the buffered index fund, essentially an index fund with bounded gains and a cushion to reduce losses that aims to achieve the benefits of equities, which traditionally have higher rates of return, while mitigating risk. But is this buffered index fund a solution for pension funds pursuing higher gains? Takash finds that a buffering strategy underperforms a simple S&amp;P 500 index fund in various time periods, often by a wide margin. Nonetheless, the buffered index could be an excellent way for pension systems with more modest (read: realistic) rates of return to hedge against future risk.<br /> <span style="font-size: 80%; color: red;">&raquo; <a href="http://reason.org/blog/show/could-buffered-index-funds-help-str">FULL BLOG POST</a></span></p>
<p><span style="font-size: 80%;">&raquo; <a href="#top">return to top</a></span></p>
<hr />
<p><a name="i"></a><strong>Glossary of Pension Terminology</strong><br />Reason Foundation</p>
<p>Research and discussions about public pension systems often involve technical terms that may be difficult to understand by lay readers, especially voters and even plan members. To assist the dialogue about pension reform, Reason Foundation has recently released a glossary covering frequently mentioned pension terms and phrases.<br /> <span style="font-size: 80%; color: red;">&raquo; <a href="http://reason.org/studies/show/glossary-of-pension-terminology">FULL GLOSSARY</a></span></p>
<p><span style="font-size: 80%;">&raquo; <a href="#top">return to top</a></span></p>
<hr />
<p><a name="j"></a><strong><span style="font-size: 120%;">Quotable Quotes on Pension Reform</span></strong></p>
<p>"[W]hile a public employee does have a 'vested right' to a pension, that right is only to a 'reasonable' pension&mdash;not an immutable entitlement to the most optimal formula of calculating the pension. And the Legislature may, prior to the employee's retirement, alter the formula, thereby reducing the anticipated pension. So long as the Legislature's modifications do not deprive the employee of a 'reasonable' pension, there is no constitutional violation."<br /><br />&mdash;State of California Court of Appeal, First Appellate District (San Francisco), <a href="http://www.courts.ca.gov/opinions/documents/A139610.PDF"><em>Marin Association of Public Employees et al., vs. Marin County Employees' Retirement Association et al., &amp; the State of California</em></a>, August 2016</p>
<p><br />"The [Marin County] ruling, if upheld by the state Supreme Court, punches a very big hole in the California rule, one large enough to accommodate some substantial changes in state and local pension promises to future retirees if politicians or voters are willing to make them. It brings something new to the pension debate and gives new life, or at least new hope, to pension reformers who have repeatedly collided with the California rule."<br /><br />&mdash;Dan Walters, "<a href="http://www.sacbee.com/news/politics-government/politics-columns-blogs/dan-walters/article97232982.html">California court opens door to changing public employee pensions</a>," <em>Sacramento Bee</em>, August 22, 2016</p>
<p><br />"The California system is great at promising pensions, but it is a failure at properly funding those promises. The first domino fell in 1999, when the state legislature granted retroactive pension payments to retirees, and they have continued to fall since with taxpayers left to pick up the pieces. Those falling dominoes have taken CalPERS from a surplus to a pension debt of more than $100 billion in just 17 years. So while '100K Club' may be on everyone's lips when referring to CalPERS, I think the expression '17 Years of Failure' is more synonymous with the organization, and more appropriate."<br /><br />&mdash;Former San Jose Mayor Chuck Reed, "<a href="http://www.retirementsecurityinitiative.org/isn_t_17_years_of_failure_enough">Isn't 17 Years of Failure Enough?</a>," Retirement Security Initiative blog, August 11, 2016</p>
<p><br />"The cost of political inertia in Sacramento and shortfalls in pension fund investment earnings will be extracted from the budgets of local government. While issues regarding anticipated investment returns and long-term debt obligation can be complex, the cost to taxpayers in taxes, fees and strained municipal finances is not."<br /><br />&mdash;"<a href="http://www.marinij.com/opinion/20160813/marin-ij-editorial-new-strategies-needed-for-public-pensions">New strategies needed for public pensions (editorial)</a>," <em>Marin Independent Journal</em>, August 13, 2016</p>
<p><br />"American public-sector pension deficits are more than $1 trillion, even on the most generous assumptions. This is an issue in which debate should not be stifled."<br /><br />&mdash;"<a href="http://www.economist.com/news/finance-and-economics/21704796-report-american-pension-funds-controversially-shelved-no-love-actuary">No love, actuary</a>," <em>The Economist</em>, August 13, 2016</p>
<p><br />"Consistent lowballing of pension costs over the past two decades has made it easy for elected officials and union representatives to agree on very valuable benefits, for very much smaller current pay concessions."<br /><br />&mdash;Jeremy Gold, quoted in Steven Malanga, "<a href="http://www.wsj.com/articles/covering-up-the-pension-crisis-1472164758">Covering Up the Pension Crisis</a>," <em>The Wall Street Journal</em>, August 25, 2016</p>
<p><br />"Pension actuaries estimate the cost, accumulating liabilities and required funding for pension plans based on longevity and numerous other factors that will affect benefit payments owed decades into the future. But today's actuarial model for calculating what a pension plan owes its current and future pensioners is ignoring the long-term market risk of investments (such as stocks, junk bonds, hedge funds and private equity). Rather, it counts "expected" (hoped for) returns on risky assets before they are earned and before their risk has been borne. Since market risk has a price&mdash;one that investors must pay to avoid and are paid to accept&mdash;failure to include it means official public pension liabilities and costs are understated."<br /><br />&mdash;Ed Bartholomew and Jeremy Gold, "<a href="http://www.marketwatch.com/story/why-your-states-public-pension-plan-is-in-a-much-bigger-hole-than-you-already-fear-2016-08-16">The $6 trillion public pension hole that we're all going to have to pay for</a>," Marketwatch.com, August 20, 2016</p>
<p><br />"Oregonians, along with the children they send to school, rightfully expect tax and employer dollars to bear fruit, not burden, and throwing money into an expanding fire is useless. Unless lawmakers prepare to act in the next legislative session, PERS threatens to undermine the capacity of the state to meet its basic obligations. Fewer school teachers, larger class sizes and the diminution of other critical government services loom.<br /><br />It's human nature to think that some problems, if ignored long enough, will just go away. The Legislature, following the court's dial-back on reforms, gave PERS no attention in its 2015 session and ignored it again this year. Yet earnings on PERS investments last year were 2.11 percent, and this year through June just 1.24 percent &mdash; well below the unrealistic PERS-set expectation, upon which the system is configured, of 7.5 percent. Problem: The problem's not going away. It's getting worse."<br /><br />&mdash;"<a href="http://www.oregonlive.com/opinion/index.ssf/2016/08/oregon_must_contain_the_roarin.html">Oregon must contain the roaring PERS fire (editorial)</a>," <em>The Oregonian</em>, August 2, 2016</p>
<p><br />"[C]onditions in public pensions tend to echo those before the savings and loan crisis really began to blossom and boil in the late 1980s. Back then, regulators allowed many effectively-insolvent S&amp;Ls to stay open, with aid of less-than-truthful accounting. This helped unleash a wave of risk taking and other less-honorable behavior to multiply the costs of resolving the S&amp;L crisis. Let's hope we aren't facing a similar set of issues in public finance, today."<br /><br />&mdash;Bill Berman, "<a href="http://www.truthinaccounting.org/news/detail/another-sign-public-pension-funds-may-be-overleveraged">Another sign public pension funds may be overleveraged</a>," Truth in Accounting blog post, August 23, 2016</p>
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<p><a name="k"></a><strong><span style="font-size: 120%;">Contact the Pension Reform Help Desk</span></strong></p>
<p>Reason Foundation set up a Pension Reform Help Desk to provide information on Reason's work on pension reform and resources for those wishing to better understand pensions or pursue reform in their states, counties, and cities. Feel free to contact the Reason Pension Reform Help Desk by e-mail at <a href="mailto:pensionhelpdesk&#64;reason.org">pensionhelpdesk&#64;reason.org</a>.</p>
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<p><em>Follow the discussion on pensions and other governmental reforms at <a href="http://www.reason.org">Reason Foundation's website</a> or on Twitter (<a href="https://twitter.com/ReasonReform?lang=en">&#64;ReasonReform</a>). As we continually strive to improve the publication, please feel free to send your questions, comments and suggestions to <a href="mailto:leonard.gilroy&#64;reason.org">leonard.gilroy&#64;reason.org</a>.</em></p>
<p>Leonard Gilroy<br />Senior Managing Director, Pension Integrity Project<br />Reason Foundation<br /><br />Anthony Randazzo<br />Managing Director, Pension Integrity Project<br />Reason Foundation</p>1014643@http://www.reason.orgWed, 28 Sep 2016 11:51:00 EDTleonard.gilroy@reason.org (Leonard Gilroy)The Only Streak That Matters is How Often Pension Investment Returns Exceed Expectationshttp://www.reason.org/news/show/only-pension-streak-that-matters
<p>Pension plans around the country have been sounding awfully happy about their really bad investment returns for the current fiscal year.</p>
<p>In July, CalPERS&rsquo;s chief investment officer <a href="https://www.calpers.ca.gov/page/newsroom/calpers-news/2016/preliminary-investment-returns">said</a> he was &ldquo;proud&rdquo; of the pension funds investment returns because 0.61% was &ldquo;positive performance.&rdquo; And last month,&nbsp;Florida&rsquo;s top pension plan investment manager was singing the praises of his fund that managed to wring out its own 0.61% return on investments this fiscal year: "The positive net returns show the value of diversification, our success in controlling costs, and the prudence and patience of sticking to the fund's long-term investment plan in a challenging year,&rdquo; <a href="http://www.gainesville.com/news/20160802/floridas-pension-fund-ekes-out-gain-in-volatile-year">said Ash Williams</a>, executive director of the State Board of Administration, which manages investments for the Florida Retirement System (FRS).&nbsp;</p>
<p>It&rsquo;s nice that they want to be so cheerful, but there is a problem with the positivity: it&rsquo;s based on an idea that the goal is to simply get returns greater&nbsp;than 0% each year. But pension systems need to do more than just avoid losing money. For the Florida Retirement System, the goal is to get returns greater than 7.65%. For CalPERS, the goal is to beat 7.5%.</p>
<p>There is nothing particularly&nbsp;special about a pension plan's return being above a threshold of 0%, or avoiding a negative sign getting attached the annual rate of return&nbsp;figure.&nbsp;Like all defined benefit plans, FRS has an assumed rate of return that is used in calculating how much should be contributed to the plan each year. That assumed rate is the <em>average return</em> the plan expects to get over a long-term period of time, i.e. a 20-year to 30-year time horizon. For FRS to average at least 7.65%, the plan has to have a number of years with returns above that benchmark&nbsp;to make up for the years where returns underperform a 7.65% threshold.</p>
<p>In this context &mdash; needing to hit an average of 7.65 percent for long-term solvency &mdash; the year&rsquo;s investment returns simply being in positive territory&nbsp;isn&rsquo;t very important. Whether a return is -1%, 0% or 1% in any&nbsp;given year&nbsp;isn&rsquo;t all that different for the long-term average. If FRS had reported a return of -0.61% it wouldn&rsquo;t have made much of a difference for the plan&rsquo;s long-term goal of a 7.65% return relative to a 0.61% return.</p>
<p>Yet, nowhere in Mr. Williams&rsquo;s recent presentation to the Florida governor and his cabinet was this emphasized.&nbsp; In fact,&nbsp;<a href="http://www.theledger.com/article/20160803/NEWS/160809827">The News Service of Florida</a> in reporting on the FRS investment returns, frames&nbsp;the 0.61% return as one that &ldquo;keeps alive a streak&rdquo; of positive investment gains for the seventh straight year in a row.</p>
<p>This is an utterly meaningless "streak."</p>
<p>If we want to look at the streaks for FRS, the point of measurement should be the number of years they&rsquo;ve returned above or below 7.65%. The figure below shows a 40-year history of FRS investment return data to look for such streaks.</p>
<p><a href="/files/pensions/Florida%20FRS/FRS Investment Return Pattern.png"><img src="/files/pensions/Florida FRS/FRS Investment Return Pattern.png" alt="" width="1921" height="1277" /></a><em>(Click Image for Larger View)</em></p>
<p>Looking at the last four decades, the FRS rate of return has&nbsp;surpassed the 7.65% assumed return 24 times. And within that context, the longest&nbsp;&ldquo;streak&rdquo; of gains above the targeted rate is six years &mdash; back in in the mid-1990s. I'm not exactly sure how meaningful such streaks are, but if anyone wants to sing praises about a streak, this would be the kind to think about.&nbsp;</p>
<p>What I am sure about is that even these streaks don't tell us much about the future.</p>
<p>Today&rsquo;s markets are not like the 1990s. In fact, the trend in large gains is getting smaller over time.&nbsp;There have been only eight years with returns above the targeted rate in the past 15 years, and only five good years in the past 10. The smaller &ldquo;streaks&rdquo; of strong investment returns reflects the change in markets, and the <a href="http://reason.org/news/show/for-pensions-systems-past-performan">new normal</a> in what are reasonable expectations for investments returns. &nbsp;</p>
<p>The 20-year average rate of return for FRS is 7.3%, but the 10-year average is 5.9% reflecting the lower returns available in modern markets. Theoretically any 10-year snapshot could be cherry picked to show a good or bad average return, but the reality is for FRS to have a 20-year average return of 7.65% by 2026 &mdash; i.e. get the 20-year average up to the assumed return over the next decade &mdash; the Florida pension fund needs to average a return of at least 9.5% for the next 10 years.</p>
<p>And that is going to&nbsp;take a lot of big investment years. Just cruising over a 0% threshold isn&rsquo;t going to cut it.&nbsp;</p>
<p>Unfortunately for pension plans with assumed rates of return over 6% (which is nearly all of them across the United States), yields on equities and bonds are forecast to be considerably lower over the next few decades relative to the past. For example, according to McKinsey most recent forecast,&nbsp;returns on U.S. equities are likely going to be 20% to 50% lower over the next 20-years than the last 30.</p>
<p>In his report to the Florida governor, Mr. Williams did accurately <a href="http://www.heraldtribune.com/article/20160803/NEWS/160809848/2107/BUSINESS?Title=Florida-public-pension-fund-ekes-out-gain-in-volatile-year&amp;tc=ar">note</a> that&nbsp;with recent market trends &ldquo;it&rsquo;s a very different world.&rdquo; However, because it is so different than the era when a pension plan could just invest mostly in bonds and get an average return of around 8%, it is inappropriate to describe 0.61% returns for a fund with a 7.65% targeted return rate as a &ldquo;success.&rdquo;</p>
<p>Two straight years, with returns below the targeted average &mdash; and three of the past five &mdash; should be taken as a warning sign that Florida, California, and all states with defined benefit or cash balance pension plans need to do something different. At a minimum, pension plans should consider lowering their expectations and risk exposure, adopt lower assumed rates of return, and&nbsp;ensure they are making the necessary contributions to fund the pension obligations being placed on the shoulders of taxpayers.&nbsp;</p>
<p><em>For more historic data and forecasts, see Reason Foundation&rsquo;s analysis of FRS returns below:</em></p>
<p><a href="/files/pensions/Florida%20FRS/FRS Investment History.png"><img src="/files/pensions/Florida FRS/FRS Investment History.png" alt="" width="1922" height="1277" /></a><em>(Click Image for Larger&nbsp;View)</em></p>
<p><a href="/files/pensions/Florida%20FRS/FRS Investment Forecast.png"><img src="/files/pensions/Florida FRS/FRS Investment Forecast.png" alt="" width="1922" height="1277" /></a><em>(Click Image for Larger&nbsp;View)</em>&nbsp;</p>1014632@http://www.reason.orgMon, 26 Sep 2016 09:00:00 EDTanthony.randazzo@reason.org (Anthony Randazzo)Pension Reform Case Study: Michiganhttp://www.reason.org/news/show/pension-reform-case-study-michigan
<p>In 1996, the Michigan state legislature passed a first-of-its-kind bill that closed the state employees&rsquo; defined benefit pension fund to new members and created a defined contribution pension system for future hires. Members already in the defined benefit system were allowed to remain and their benefits continued to accrue as originally promised, though the workers were given an opportunity to take a buyout of their earned benefits and have those transferred to a defined contribution account. New workers had their pension contributions put into personal accounts that they could manage on their own and take with them if they left employment with the state.</p>
<p>Given that the state employees&rsquo; defined benefit fund had a relatively healthy funding ratio at the time, this was an unusual move. But in retrospect, the decision seems highly prescient. Pension reform in Michigan has meant the State Employee Retirement system is more solvent today than if the legislature had not closed the defined benefit plan for new hires, with a full system funded ratio of 88% as of 2015, compared to an estimated 68% funded ratio without reform.</p>
<p>However, while Michigan provides valuable insights for how to pursue adopting pension reform&mdash;such as taking sufficient time to fully analyze a pension plan&rsquo;s problems, avoiding conflict by communicating with all parties, and having determined elected officials leading the effort&mdash;the state has also provided an example of how not to manage the implementation of pension reform.</p>
<p>This 2016 update to our original study finds:</p>
<ul>
<li>Michigan&rsquo;s poor management of the pension reform process has directly led to the state&rsquo;s growth in unfunded liabilities over the past two decades. A properly managed pension reform process would have added about $8.4 billion to the assets of state employee retirement plan&nbsp;as of 2015, meaning the plan would be overfunded instead of deep in the red.</li>
<li>Closing the state employee&nbsp;defined benefit plan has prevented the state from taking on even more unfunded liabilities than without a change. But the positive effects of pension reform have been muted by the failure to manage the defined benefit plan well as it is being closed over time.</li>
<li>Collectively, the process of reforming the Michigan State Employees' Retirement System provides a number of lessons for policymakers today facing similar challenges to their pension plans.</li>
</ul>1013744@http://www.reason.orgMon, 15 Aug 2016 00:00:00 EDTanthony.randazzo@reason.org (Anthony Randazzo)Pension Reform Newsletter - August 2016http://www.reason.org/news/show/pension-reform-newsletter-aug16
<p>This newsletter from Reason Foundation's Pension Integrity Project highlights articles, research, opinion, and other information related to public pension challenges and reform efforts across the nation. You can find previous editions <a href="http://reason.org/newsletters/pensionreform/">here</a>.</p>
<p><strong><span style="font-size: 120%;">In This Issue:</span></strong></p>
<p><strong><a href="#a">Articles, Research &amp; Spotlights</a></strong></p>
<ul type="disc">
<li><a href="#b">Pension Boards Should Focus on Returns, Not Divestment</a></li>
<li><a href="#c">For Public Pensions, Past Performance No Guarantee of Future Results</a></li>
<li><a href="#d">Accounting Rules Create Perverse Risk-Taking Incentives for U.S. Public Pension Funds</a></li>
<li><a href="#e">Pension Fund Investment in P3 Infrastructure</a></li>
<li><a href="#f">More Participant-Elected Pension Board Members Associated with Lower Bond Ratings</a></li>
<li><a href="#g">Pension Underfunding in Alabama</a></li>
<li><a href="#h">Sonoma County (CA) Pension Advisory Committee Update</a></li>
<li><a href="#i">Glossary of Pension Terminology</a></li>
</ul>
<p><strong><a href="#j">Quotable Quotes on Pension Reform</a></strong></p>
<p><strong><a href="#k">Pension Reform Handbook</a></strong></p>
<p><strong><a href="#l">Contact the Pension Reform Help Desk</a></strong></p>
<hr />
<p><a name="a"></a><strong><span style="font-size: 120%;">Articles, Research &amp; Spotlights</span></strong></p>
<p><a name="b"></a><br /><strong>Pension Boards Should Focus on Returns, Not Divestment</strong></p>
<p>Activists continue to pressure public pension systems to divest from a number of different industries, including tobacco and gun manufacturers. But as Reason's Daniel Takash writes in a new article, it is unwise for pension funds to promote social change at the expense of pensioners. As the fiduciaries of public sector pension funds, pension boards have a primary obligation to maximize fund returns for the benefit of the pensioners rather than employing these funds to achieve political ends.<br /> <span style="font-size: 80%; color: red;">&raquo; <a href="http://reason.org/news/show/pensiondivestment">FULL ARTICLE</a></span></p>
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<p><a name="c"></a><strong>For Public Pensions, Past Performance No Guarantee of Future Results</strong></p>
<p>We're all routinely told that "past performance is no guarantee of future results" when it comes to our investment portfolios, but in the world of public sector pensions, politicians regularly ignore that mantra. In a recent <em>Orange County Register</em> column, Reason's Len Gilroy writes that policymakers still pretend they can rely on high annual investment returns every year, disregarding a "new normal" in the markets that threatens rising costs to taxpayers, declining pension solvency, and diminished retirement security.<br /> <span style="font-size: 80%; color: red;">&raquo; <a href="http://www.ocregister.com/articles/percent-724808-returns-pension.html">FULL ARTICLE</a></span></p>
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<p><a name="d"></a><strong>How Accounting Rules Create Perverse Risk-Taking Incentives for U.S. Public Pension Funds</strong></p>
<p>U.S. public pension funds can set their discount rates based on their expected returns, a practice at odds with the prudent liability-based approach used by U.S. corporate pension funds and pension funds in other countries. Reason's Truong Bui recently summarized new research finding that not only does the expected-return approach undervalue pension liabilities, but it also encourages public plans to increase risk taking in their investments to sustain unreasonably high discount rates.<br /> <span style="font-size: 80%; color: red;">&raquo; <a href="http://reason.org/blog/show/how-accounting-rules-create-pervers">FULL ARTICLE</a></span></p>
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<p><a name="e"></a><strong>Pension Fund Investment in P3 Infrastructure</strong></p>
<p>Public pension fund investment in infrastructure public-private partnerships continues to be a major global trend, motivated by the difficulty of achieving pension funds' needed 7-8% overall return on their investment portfolios in today's very low interest-rate environment. In a recent <em>Public Works Financing</em> column, Reason's Robert Poole explores this trend and the policy and political implications.<br /> <span style="font-size: 80%; color: red;">&raquo; <a href="http://reason.org/news/show/pension-fund-investment-in-p3-infra">FULL ARTICLE</a></span></p>
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<p><a name="f"></a><strong>More Participant-Elected Pension Board Members Associated with Lower Bond Ratings</strong></p>
<p>The board of trustees of a public pension plan has a large influence over the plan's investments, asset allocation, actuarial assumptions, and benefit levels. Reason's Truong Bui recently summarized a new study finding that elected board members may be less financially literate than appointed and ex-officio board members, who tend to have stronger financial backgrounds and thus may be inclined to adopt sounder pension policies. This implies that it may be beneficial for public plans to have more members with financial expertise on the board.<br /> <span style="font-size: 80%; color: red;">&raquo; <a href="http://reason.org/blog/show/new-paper-finds-more-participant-el">FULL ARTICLE</a></span></p>
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<p><a name="g"></a><strong>New Study Examines Pension Underfunding in Alabama</strong></p>
<p>A new report by researchers at Troy University examines factors influencing the declining performance of the Retirement Systems of Alabama, noting the limitations of using Actuarially Determined Employer Contributions in interpreting a system's fiscal health. In a recent blog post, Reason's Anil Niraula reviews the report, which demonstrates that a detailed analysis of state pension systems, unlike aggregate studies, offers an opportunity to account for the unique political, economic, demographic and financial landscape factors that a particular retirement system faces.<br /> <span style="font-size: 80%; color: red;">&raquo; <a href="http://www.reason.org/blog/show/pension-underfunding-alabama">FULL BLOG POST</a></span></p>
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<p><a name="h"></a><strong>Update from the Sonoma County (CA) Pension Advisory Committee</strong></p>
<p>The Sonoma County (CA) Independent Citizens Advisory Committee on Pension Matters released a report last month detailing how the county's pension liability has grown so rapidly in the past 15 years. Reason's Daniel Takash examines the report in a recent blog post, summarizing its findings and recommendations.<br /> <span style="font-size: 80%; color: red;">&raquo; <a href="http://reason.org/blog/show/sonomapensions">FULL BLOG POST</a></span></p>
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<p><a name="i"></a><strong>Glossary of Pension Terminology</strong><br />Reason Foundation</p>
<p>Research and discussions about public pension systems often involve technical terms that may be difficult to understand by lay readers, especially voters and even plan members. To assist the dialogue about pension reform, Reason Foundation has recently released a glossary covering frequently mentioned pension terms and phrases.<br /> <span style="font-size: 80%; color: red;">&raquo; <a href="http://reason.org/studies/show/glossary-of-pension-terminology">FULL GLOSSARY</a></span></p>
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<p><a name="j"></a><strong><span style="font-size: 120%;">Quotable Quotes on Pension Reform</span></strong></p>
<p>"The longer-term returns of [CalPERS]&mdash;the three-, five-, 10-, 15- and 20-year total returns of the fund&mdash;are now below the assumed rate of 7.5 percent for the fund [...] That's a significant policy issue for us."<br /><br />&mdash;CalPERS Chief Investment Officer Ted Eliopoulos, quoted in John Gittelsohn, "<a href="http://www.bloomberg.com/news/articles/2016-07-18/calpers-largest-u-s-pension-fund-earned-0-6-last-fiscal-year">Calpers Earns 0.6% as Long-Term Returns Trail Fund's Target</a>," <em>Bloomberg</em>, July 18, 2016.</p>
<p><br />"It's a systemic problem [&hellip;] Everything is predicated on a linear 7.5 percent investment return, and that has not been sustainable. It's a whole different paradigm to what we've been use[d] to in the past."<br /><br />&mdash;Oregon Public Employee Retirement System Board Chairman John Thomas, quoted in Ted Sickinger, "<a href="http://www.oregonlive.com/politics/index.ssf/2016/07/pers_oregons_public_pension_co.html">PERS: Oregon's public pension costs will go up $885M next year</a>," <em>The Oregonian</em>, July 30, 2016.</p>
<p><br />"The good times almost certainly will roll again, but the question is whether there will be enough of those good years to fill in the craters left by years like the last two. It would be better for state and local governments to start grappling with the higher cost of lower pension-fund returns now, rather than waiting until more drastic and painful steps are forced upon them."<br /><br />&mdash;<em>Los Angeles Times</em> editorial board, "<a href="http://www.latimes.com/opinion/editorials/la-ed-calpers-returns-20160726-snap-story.html">Another bad year for CalPERS</a>," July 27, 2016.</p>
<p><br />"[&hellip;] American accounting regulations have created perverse incentives for public pension funds. And that can mean only one thing. The rules need to change."<br /><br />&mdash;&ldquo;<a href="http://www.economist.com/news/business-and-finance/21702623-rules-encourage-public-sector-pension-plans-take-more-risk-putting-it-all">Why public-sector pension plans take more risk</a>," <em>The Economist</em>, July 25, 2016.</p>
<p><br />"If we don't find a way to reduce the expanding debt around our public pensions, no contract will overcome the unforgiving laws of mathematics. It's this plain: without meaningful reform, both taxpayers and our retirees could be at risk."<br /><br />&mdash;Pennsylvania House Speaker Mike Turzai, "<a href="http://www.post-gazette.com/opinion/Op-Ed/2016/08/05/Rep-Mike-Turzai-State-pension-fix-needed/stories/201608310022">State pension fix needed</a>," <em>Pittsburgh Post-Gazette</em>, August 5, 2016.</p>
<p><br />"Unlike Berkshire, CalSTRS may not claim it is safely funded at anything less than assets equal to 100% of liabilities. That concept applies only when the discount rate is less than the expected rate of return. This explains why the so-called "80% rule," a frequently mis-cited rule of thumb that pension funds are safely funded so long as assets equal or exceed 80% of pension obligations, does not apply to pension funds that discount obligations at the same rate as they expect to earn on assets. When discount rate = expected rate of return, only 100% funding is safe."<br /><br />&mdash;David Crane, "<a href="https://medium.com/&#64;DavidGCrane/truth-or-consequences-77f868d3ad64#.j0paen9rn">Truth Or Consequences</a>," (blog post), July 21, 2016.</p>
<p><br />"[S]ome pension fund officials continue to peddle the notion that the market will bail them out. The chief investment officer of CalSTRS downplayed the fund's recent poor performance, telling <em>Wall Street Journal</em> that, 'we look at performance in terms of decades, not years.' But the debt of CalSTRS and its sister fund, CalPERS, rose from $60 billion in 2008 to $180 billion today despite a string of years when both funds far exceeded their investment goals.<br /><br />Dr. Johnson once famously described second marriages as the triumph of hope over experience. Unfortunately, today that sounds like the operating philosophy of much of the public sector pension world."<br /><br />&mdash;Steven Malanga, "<a href="http://www.investors.com/politics/commentary/the-public-pension-problem-its-much-worse-than-it-appears/">The Public Pension Problem: It's Much Worse Than It Appears</a>," <em>Investor's Business Daily</em>, July 22, 2016.</p>
<p><br />"But just as a pig with lipstick is still a pig, a pension fund in crisis is still in crisis, and ignoring that reality benefits no one, including pensioners."<br /><br />&mdash;Dan Walters, "<a href="http://www.modbee.com/opinion/state-issues/article90809452.html">CalPERS' unfunded liabilities grow as investment earnings lag</a>," <em>Sacramento Bee</em>, July 20, 2016.</p>
<p><br />"The enormity of the challenges confronting pension funds &mdash; including substantial deficits, a tumultuous global economy, and a low-return environment &mdash; means that they need to be able to focus on maximizing investment returns without distraction. For those in the public sector, this includes being shielded from governmental politics. Interference by elected officials &mdash; from imposition of local economic development obligations to excessive constraints on head count and compensation that impede recruitment of talented staff &mdash; has contributed to poor investment choices, higher total costs, diminished organizations, and disappointing performance at some institutions."<br /><br />&mdash;Simon C.Y. Wong, "<a href="https://hbr.org/2016/07/public-pension-funds-perform-better-when-they-keep-politics-at-bay">Public Pension Funds Perform Better When They Keep Politics at Bay</a>," <em>Harvard Business Review</em>, July 19, 2016.</p>
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<hr />
<p><a name="k"></a><strong><span style="font-size: 120%;">Pension Reform Handbook</span></strong></p>
<p>For those interested in the process and mechanics of pension reform, Reason Foundation published a <a href="http://reason.org/news/show/pension-reform-handbook-a-starter-g">comprehensive starter guide</a> for state and local reformers. This handbook aims to capture the experience of policymakers in those jurisdictions that have paved the way for substantive reform, and bring together the best practices that have emerged from their reform efforts, as well as the important lessons learned.<br /> <span style="font-size: 80%; color: red;">&raquo; <a href="http://reason.org/news/show/pension-reform-handbook-a-starter-g">FULL HANDBOOK</a></span></p>
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<p><a name="l"></a><strong><span style="font-size: 120%;">Contact the Pension Reform Help Desk</span></strong></p>
<p>Reason Foundation set up a Pension Reform Help Desk to provide information on Reason's work on pension reform and resources for those wishing to pursue pension reform in their states, counties, and cities. Feel free to contact the Reason Pension Reform Help Desk by e-mail at <a href="mailto:pensionhelpdesk&#64;reason.org">pensionhelpdesk&#64;reason.org</a>.</p>
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<p><em>Follow the discussion on pensions and other governmental reforms at <a href="http://www.reason.org">Reason Foundation's website</a> or on Twitter (<a href="https://twitter.com/ReasonReform?lang=en">&#64;ReasonReform</a>). As we continually strive to improve the publication, please feel free to send your questions, comments and suggestions to <a href="mailto:leonard.gilroy&#64;reason.org">leonard.gilroy&#64;reason.org</a>.</em></p>
<p>Leonard Gilroy<br />Senior Managing Director, Pension Integrity Project<br />Reason Foundation<br /><br />Anthony Randazzo<br />Managing Director, Pension Integrity Project<br />Reason Foundation</p>1014613@http://www.reason.orgThu, 11 Aug 2016 15:39:00 EDTleonard.gilroy@reason.org (Leonard Gilroy)A Collaborative Process for Pension Reformhttp://www.reason.org/news/show/a-collaborative-process-for-pension
<p>At a time when differences of opinion regarding public policies are growing wider and partisanship is increasing rapidly, is there any hope for solving any of the vexing, complex issues of our time? Arizona&rsquo;s recent experience with the challenging issue of pension reform suggests that there is.&nbsp;</p>
<p>Last month, Arizona Governor Doug Ducey <a href="http://reason.org/news/show/az-public-safety-pension-reform">signed comprehensive pension reform legislation</a>&nbsp;for public safety officers into law. This pension reform is notable not only for the <a href="http://reason.org/news/show/az-pension-reform-fiscal-review">positive fiscal impacts for taxpayers </a>and the sustainability it brings to the pension system, but also for the process used to craft the legislation and the widespread, broad bipartisan support it garnered along the way.</p>
<p>In 2014, Arizona public safety employees and their unions were becoming increasingly concerned about the fiscal state of the Public Safety Personnel Retirement System (PSPRS)&mdash;which covers all law enforcement personnel and firefighters statewide. The plan had been steadily deteriorating over a decade, with the funding ratio falling to around 50% and unfunded liabilities reaching into the billions. Legislation was passed in 2011 that sought to pay down unfunded liabilities by increasing employee contributions to the plan, but state courts rejected those changes as a violation of the Arizona constitution. Concern that their retirement security was jeopardy reached a point that, possibly for the first time in the nation, a coalition of public safety unions approached Republican state legislators in an effort to reform the pension system.&nbsp;</p>
<p>Senate President Andy Biggs and Senate Finance Committee Chairwoman Debbie Lesko welcomed the prospect of reform, but knew that any potential reform would need careful vetting in order to avoid the legal challenges that have vexed many previous reform efforts, both in Arizona and across the nation. With this in mind, Senator Lesko launched a year-long, collaborative stakeholder process to fully analyze the PSPRS system and potential reform options.</p>
<p>As of June 30, 2015, the plan had accumulated $6.6 billion in unfunded liabilities and dropped to just 48% funded. Arizona cities and towns are have been struggling to pay the soaring pension bills, facing a choice between cutting services or raising taxes as a result. A number of cities have run out of fiscal options and, for some, the threat of bankruptcy is looming.</p>
<p>In February 2015, Sen. Lesko organized the first of a series of monthly meetings for a broad range of stakeholders of the PSPRS system: employees, retirees, Gov. Ducey&rsquo;s office, members of the legislature, PSPRS administrators, union leadership, the Arizona League of Cities and Towns, county representatives, and taxpayer advocates. From the beginning of the process, Sen. Lesko asked Reason Foundation's Pension Integrity Team to assist with providing education, policy options, and actuarial analysis for the stakeholders.</p>
<p>Any hope of stakeholder consensus on a reform package depended on overcoming personal preconceived opinions and putting all potential reform scenarios on the negotiation table for discussion, analysis and vetting. The Pension Integrity Team&rsquo;s proposed general framework for the goals of pension reform helped stakeholders focus on whether a proposed plan change furthered the common goals of:</p>
<p>1. Providing retirement security for all members (current and future) and retirees;</p>
<p>2. Reducing taxpayer and pension system exposure to financial risk and market risk;</p>
<p>3. Reducing long-term costs for employer/taxpayers and employees;</p>
<p>4. Stabilizing contribution rates;</p>
<p>5. Ensuring ability to recruit 21<sup>st</sup> century employees; and</p>
<p>6. Improving governance and transparency.</p>
<p>Along the way, stakeholder disagreements&mdash;some forceful&mdash;threatened to derail the process. For example, negotiations began to break down after the firefighters&rsquo; association asked mayors state-wide to vote against an Arizona League of Cities and Towns&rsquo; resolution supporting a set of principles a League task force developed to evaluate any reform legislation. The Pension Integrity Team quickly brought both sides together to examine the cause of their sudden opposition. During this process the Team determined they were both advocating for the exact same thing&mdash;only using different terms that each side misinterpreted. It is not uncommon in pension finance for groups to use different words and phrases to convey the same concepts, or the same words to convey different concepts, but the PSPRS stakeholders were not aware of this. The Pension Integrity Team responded by establishing a durable and common lexicon of pension reform to foster progress in deliberation.&nbsp; By re-establishing a common ground of terms, the clear intent of the resolution pleased all parties, and it moved forward receiving strong support from cities and towns throughout the state.</p>
<p>By the summer of 2015, the Pension Integrity Team&rsquo;s diplomatic role evolved, facilitating consensus among stakeholders on the reform&rsquo;s conceptual design and framework. The Team&rsquo;s expertise helped multiple stakeholders actuarially vet their ideas for improving PSPRS, including suggestions from Sen. Lesko, a public sector union, and the League of Cities. The scope of these proposals started far apart, leading to unproductive working group meetings. Multiple times individuals or stakeholder groups threatened to quit the process. Other times contentious topics polarized stakeholders, further threatening the reform&rsquo;s progress. At times negotiations shifted to a &ldquo;shuttle diplomacy&rdquo; of stakeholder parties staying at the table and communicating primarily through the Pension Integrity Team, which parsed and refined individual concepts of reform to foster consensus.&nbsp;</p>
<p>Over time, the various stakeholders gained enough trust with each other, and enough appreciation of the reform&rsquo;s intent, for all sides to grant concessions in order to keep the reform progressing. The public safety labor union&rsquo;s key priority was maintaining a 2.5% defined benefit multiplier for members who worked a full career; the legislature prioritized reducing taxpayer risks and avoiding added substantial near-term cost to the plan. The final reform legislation was able to <a href="http://reason.org/news/show/az-pension-reform-fiscal-review">achieve both of these priorities</a>.&nbsp;</p>
<p>In the end, the collaborative stakeholder process crafted pension reform legislation that was comprehensive in scope, meaningful in fiscal effect&mdash;and agreed upon by Republicans and Democrats, employees and employers, business organizations and labor unions, and taxpayers and legislators. As the final piece of the reform legislation goes to voters for approval, key stakeholders&mdash;the Professional Fire Fighters of Arizona, Phoenix Law Enforcement Association, Arizona Fraternal Order of Police, League of Arizona Cities and Towns, and The Arizona Chamber of Commerce and Industry&mdash;have all endorsed the ballot measure.</p>
<p>It&rsquo;s easy to understand why. This reform is as close to a win-win as practical:</p>
<ul>
<li>Government agencies will realize substantial savings (up to 43%) with each new public safety officer hired;</li>
<li>Taxpayers will have their future exposure to risk reduced by more than 50%;</li>
<li>The Arizona Public Safety Personnel Retirement System will see a 36% reduction in the future accrual of new employee pension liabilities;</li>
<li>Future pension contributions will be significantly less volatile for both employers and employees;</li>
<li>New employees, for the first time, will have the choice to select a portable pension benefit;</li>
<li>Retirees will enjoy more retirement security and assurance of benefit increases whenever Arizona&rsquo;s cost of living increases.</li>
</ul>
<p>These are just a few of the benefits. For a more complete list of reform elements, click <a href="http://reason.org/news/show/az-public-safety-pension-reform">here</a>&nbsp;and <a href="http://reason.org/files/az_psprs_reform_analysis_2016jan29.pdf">here</a>.&nbsp;</p>
<p>Not everyone got exactly what they wanted. Some said the reform took away too many benefits; others said the reforms didn&rsquo;t go far enough. Some stakeholders ultimately opposed the reform on these grounds. Yet, even the few who voiced opposition to the final legislation supported many individual concepts contained within the reform, despite opposing the final package.&nbsp;</p>
<p>The process that forged this reform is as significant as the reform itself. Senator Lesko deserves credit for her strong leadership and commitment to the process. All of the stakeholders deserve credit for their willingness to see the reform from all sides and their flexibility in yielding to achieve consensus.</p>
<p>The stakeholder process worked because building relationships builds trust, which shares the ownership of ideas. Consensus-based decision-making requires that individuals consider the needs of all the diverse groups affected, not personal or political interests.</p>
<p>Arizona&rsquo;s ability to enact meaningful reform on the often-contentious issue of pension reform shows that in today&rsquo;s bitterly divided political environment, we need more policymakers to welcome and encourage collaborative, consensus building to find solutions to the complex issues facing government agencies across the nation.</p>1014504@http://www.reason.orgMon, 04 Apr 2016 18:28:00 EDTinfo@reason.org (Pete Constant)Confronting Myths About Closing Defined Benefit Planshttp://www.reason.org/news/show/closing-defined-benefit-plan-myths
<p>Can closing a defined benefit pension plan directly lead to the creation of unfunded liabilities? The question is an important one as policymakers consider the various options on the table for responding to the public sector pension crisis facing most states in America. Unfortunately, there are several predominant myths about the closing of defined benefit plans that are often repeated when this question is considered.</p>
<p>In a <a href="http://reason.org/blog/show/counterfactual-pension-reform-analy">recent policy study</a>, Truong Bui and I analyzed the actuarial experience of Michigan and Alaska since their respective pension reform efforts that closed defined benefit plans and replaced them with defined contribution plans for new hires. For each state, we forecast several counterfactual scenarios to determine what the level of unfunded liabilities in their pension plans would have been if pension reform had <em>not</em> been adopted.</p>
<p>Across the board we find that closing defined benefit pension plans has made states more solvent than if they hadn&rsquo;t adopted their respective reform efforts:</p>
<ul>
<li>Michigan is more than $7 billion better off for closing the defined benefit tier of its general employee plan than without pension reform; and</li>
<li>Alaska is more than $4 billion better off for closing its two defined benefit plans because of reform.<a href="#_edn1" name="_ednref1">[1]</a></li>
</ul>
<p>Our findings support the arguments others have made about the pension reform efforts; in particular that closing defined benefit plans has helped <a href="https://www.alec.org/article/alaska-pension-reform/">improve Alaska&rsquo;s credit rating</a>&nbsp;and <a href="https://www.mackinac.org/15284">saved Michigan taxpayers money</a>. However, our paper also stands in contrast to analyses of Michigan and Alaska&rsquo;s pension reform efforts that claim that closing the defined benefit plans has <em>caused</em> debt to rise in both states. These latter claims should be directly addressed and dismissed. &nbsp;</p>
<p><strong>Myth: Unfunded liabilities increased in Michigan and Alaska after pension reform was adopted, therefore pension reform has been a failure.</strong></p>
<p><strong>Truth: There are many factors that have caused the growth of unfunded liabilities, but pension reform is not one of them; correlation of reform with debt growth does not necessarily mean reform caused debt growth.</strong></p>
<p>Since Michigan and Alaska closed defined benefit pension plans, both states have seen unfunded liabilities increase. Critics of pension reforms that close defined benefit plans, and offer new hires defined contribution plans, often argue that pension reform has <em>caused</em> this increase in unfunded liabilities. In a <a href="http://bit.ly/1EVJaZi">March 2015 op-ed</a>&nbsp;opposing pension reform in Nevada, economist Teresa Ghilarducci claimed:</p>
<p style="padding-left: 30px;"><em>States that have experimented with a transition to 401(k)-style systems have exacerbated rather than solved their debt problems. Michigan started enrolling all new state employees in a 401(k)-type plan in 1997. The system&rsquo;s unfunded liabilities increased from $697 million in 1997 to $4.1 billion 13 years later.</em><a href="#_edn1" name="_ednref1">[2]</a></p>
<p>This claim is both overly simplistic and misleading. The inference is that because new employees were enrolled in a defined contribution plan, while the outstanding defined benefit plan was closed, that the unfunded liabilities increased. Or at least, this is inferring that creating a defined contribution plan didn&rsquo;t prevent the growth of pension debt. However, simplistic correlation analysis doesn&rsquo;t allow for the possibility that pension debt would have been even higher without the reform, and that the growth of unfunded liabilities could be structurally unrelated to closing a defined benefit plan.</p>
<p>As we discuss in detail in our recent policy study on the effects of pension reform on plan solvency&mdash;as well as in an updated case study of Michigan&rsquo;s pension reform for the State Employees Retirement System (MSERS)&mdash;the proximate causes of an increase in unfunded liabilities in Michigan over the past two decades have been:</p>
<ol>
<li><em>The systematic underfunding of MSERS&rsquo;s required contributions by about $570 million since 1997.</em> Michigan simply stopped paying 100% of the actuarially determined contributions necessary to properly fund the defined benefit plan, which was a policy decision inherently separate from putting new employees in to a defined contribution plan.</li>
<li><em>The underperformance of plan assets, with an average return of 7.1% between 1997 and 2014 instead of the 8% assumed rate of return.</em> This poor investment return was not a result of the MSERS pension reform. Investment strategy did not change to fulfill any requirements relative to the reform, and the actual rate of return would have been less than the amount expected with or without closing the defined benefit plan.</li>
<li><em>The use of a discount rate that consistently undervalued MSERS accrued liabilities</em>. We estimate that normal cost rates have been at least $2 billion less than necessary to pay future benefits simply because the plan is undervaluing accrued liabilities.<a href="#_edn2" name="_ednref2">[3]</a></li>
<li><em>The misuse of pension assets to guarantee private sector investments.</em> The state pledged pension assets as a backstop for an $18 billion bond issuance to Michigan Motion Picture Studios. The business ultimately failed to meet revenue projections, missed a bond payment, and triggered a multi million payout to bond holders from pension fund assets.</li>
<li><em>Retrospective benefit changes. </em>An early retirement incentive program that offered an increase in benefits to leave the plan but without funding the actuarial costs of the change to MSERS&rsquo;s obligations.</li>
</ol>
<p>Just because unfunded liabilities increased between 1997 and 2010 doesn&rsquo;t mean it was the closing of the defined benefit tier of the plan that <em>caused</em> the increase.</p>
<p>&nbsp;</p>
<p><strong>Myth: Closing defined benefit plans inherently increases unfunded liabilities because of the declining number of active members in the plan.</strong></p>
<p><strong>Truth: For employees in Michigan and Alaska, defined benefit plan contributions are intended to pay only for normal cost, with employer contributions covering all unfunded liabilities. Defined benefit pensions differ from Social Security where the cash flow of active members is needed to pay for retiree benefits (i.e. pay-as-you-go). With defined benefit pension plans employee contributions cover a portion of their own benefits and are always refundable (i.e. pre-funded). </strong></p>
<p>There is a technical claim that closing a defined benefit plan inherently leads to increases in unfunded liabilities because it reduces contributions into the plan, specifically, because unfunded liability contributions based on the payroll of active members gets reduced overtime. Citing a <a href="http://lat.ms/1JfMLiR">2015 paper</a>&nbsp;from the National Institute on Retirement Security (NIRS), columnist Michael Hiltzik wrote:</p>
<p style="padding-left: 30px;"><em>The main problem with closing defined benefit plans is that the demographics within the closed plans change quickly. Without new members coming in, the number of active workers making contributions shrinks. The loss of young members making contributions for years before retirement is especially damaging.</em><a href="#_edn3" name="_ednref3">[4]</a></p>
<p>That argument was based in part on <a href="http://bit.ly/1cy9HQl">this claim from NIRS</a>&nbsp;about Alaska:</p>
<p style="padding-left: 30px;"><em>Generally speaking, when a DB plan is frozen, plan costs will increase. This is because the plan&rsquo;s demographics tend to change rapidly&hellip; New members of a DB pension, by definition, do not start with any unfunded obligation for benefits. So, if Alaska kept open the DB pensions instead, these new employees would have resulted in the DB pensions getting a net funding contribution from a stable or growing group of employees rather than an ever smaller payroll base over which to spread the payments to meet the unfunded liabilities.</em><a href="#_edn4" name="_ednref4">[5]</a></p>
<p>If this statement were accurate, it would mean the best strategy for reforming a pension plan would be to hire as many people as possible. But, instead, the argument fails to accurately articulate how defined benefits plans are funded. (See <a href="http://reason.org/news/show/how-defined-benefit-plans-funded">Reason's backgrounder on&nbsp;how pensions are funded</a>.) It is true that new members of a plan would start out with zero unfunded liabilities. However, the new members would only mean additional contributions to a plan relative to the additional accrued liabilities&mdash;i.e. promised pension benefits&mdash;they would bring. The new members would not have resulted in extra contributions to help pay for previous member liabilities&mdash;funded or unfunded.<a href="#_edn5" name="_ednref5">[6]</a></p>
<p>Consider a counterfactual scenario where Alaska didn&rsquo;t close the defined benefit plan for teachers (ATRS) but instead put all new teacher employees in a new Tier 2 with slightly altered benefits, but still defined benefits. The annual contributions made to the plan as a whole on behalf of the Tier 2 members would be only what is actuarially determined as necessary to fund the accrued liabilities of Tier 2 members in a given year, assuming a particular rate of return on the assets. The &ldquo;net&rdquo; contributions to the plan would be neutral relative to the additional liabilities from the new members. The contributions would have no bearing on the normal cost of Tier 1 members&mdash;for which separate contributions would be made&mdash;or for the unfunded liabilities of Tier 1 members. In practice this would be no different from keeping a plan open in general without separate tiers; it is just that the contributions on behalf of various employees are all bunched together, making it difficult to recognize at a glance how the funding actually works.</p>
<p>Moreover, the NIRS statement tacitly confuses expenses and costs. It is true that, when a pension plan is closing, the payroll gets reduced over time. However, the same dollar amount can be 10% of one amount of payroll and 50% of another amount of payroll, but it will still be the same expense. If a pension plan has a level-dollar amortization method, then over time the amortization payments will be measured as increasing as a percentage of payroll, but the percentage of payroll figure isn&rsquo;t particularly relevant, as it is the dollar amount paying down pension debt that is measured in dollars.</p>
<p>The use of payroll as a medium for determining the rate an employer should pay toward pension debt isn&rsquo;t anything more than a method for calculating a dollar amount. Every year the dollars that make the amortization payments in Michigan and Alaska flow out of general revenue of employers and into the plan assets of MSERS, APERS, and ATRS. Payroll also flows out of general revenue and into the bank accounts of employees. Additional employees would mean additional paychecks, but the dollars to pay the unfunded liabilities would come from the same source, with or without those employees.</p>
<p>Theoretically, it doesn&rsquo;t matter if those dollar amounts are determined using a percentage of the payroll of active members or a percentage of income tax revenue, so long as there is a plan in place to pay off the unfunded liability. Having a declining payroll only means the dollar payments will have a larger percentage of payroll numerical representation, not that the actual costs of paying off the unfunded liability are somehow higher.</p>
<p>&nbsp;</p>
<p><strong>Myth: &ldquo;Transitioning&rdquo; from defined benefit to defined contribution inherently increases taxpayer costs.</strong></p>
<p><strong>Truth: Closing a defined benefit plan does not require a state to change the annual dollar amounts it is planning to pay toward its remaining unfunded liabilities.</strong></p>
<p>Finally, there is a claim that the very nature of &ldquo;transitioning&rdquo; from defined benefit to defined contribution entails costs. In <a href="http://bit.ly/1VuthhW">testimony before a legislative committee in Nevada</a>&nbsp;that was considering closing the state&rsquo;s defined benefit plan, Ghilarducci claimed:</p>
<p style="padding-left: 30px;"><em>[Since Alaska&rsquo;s] 401(k)-type plan for new state and public school employees began in 2006&hellip;. Alaska required contribution rates nearly doubled. For Alaska state employees, the actuarially determined employer contribution rate required to pay off the unfunded liabilities increased from 12.4 percent of salary in 2006 to 22.5 percent in 2012. For teachers it was worse, the rate increased from 24.6 percent to 36 percent.</em><a href="#_edn6" name="_ednref6">[7]</a></p>
<p>There is nothing about closing a defined benefit plan that automatically increases contribution rates. The policy decisions of a state may increase contributions in the near-term due to a change in the amortization schedule that pays the debt off faster or defined contribution rates that are designed to be higher than defined benefit normal cost. The increase in contribution rate requirements in the years following a pension reform in Michigan and Alaska was specifically due to an increase in unfunded liability amortization payments.</p>
<p>The increase in amortization payments was not directly related to the closing of a defined benefit plan either. As outlined before, there are direct causes for the growth of pension debt due to the actuarial experience of the plans and funding policy of the plans&mdash;both of which would have affected Michigan and Alaska&rsquo;s plans without reform. (And in Alaska, part of the increase in unfunded liabilities is due to a change in the discount rate, meaning the growth in pension debt was in part due to more honest and accurate accounting that does not undervalue pension liabilities as badly as before.<a href="#_edn7" name="_ednref7">[8]</a>)</p>
<p>Thus, Ghilarducci mischaracterizes the causes of the increase in unfunded liabilities, inappropriately laying it at the feet of the nature of closing a defined benefit plan instead of at the feet of a mismanagement of the closed pension plans. The growth of pension debt experienced by Alaska&rsquo;s APERS and ATRS plans would not have happened if the return on investments had met the assumed average return and if the state had paid its actuarially determined employer contributions. Adopting a more manageable investment return target and paying the full costs of the plan shouldn&rsquo;t be that much to expect of those responsible for funding public sector retirement benefits.</p>
<p>Moreover, even with the mismanagement, Alaska&rsquo;s APERS and ATRS plans still have less in unfunded liabilities today than they would without reform. Closing a defined benefit plan closes the plan off to the liabilities that come with new hires&mdash;liabilities that are exposed to the undervaluing of improper discount rates and underperforming investment returns.</p>
<p>The reason that NIRS, Ghilarducci, and others perpetuate the myths about Michigan and Alaska is because they underappreciate the dramatic role that underperforming investment assets and underfunding contribution rates has played in <em>causing</em> the growth in unfunded liabilities. For Michigan, NIRS acknowledges that &ldquo;other factors&rdquo; have contributed to Michigan&rsquo;s unfunded liability, including underperforming investments and underfunding the employer contributions.<a href="#_edn8" name="_ednref8">[9]</a> However, it fails to attribute proper weight to these &ldquo;factors.&rdquo; The losses during the financial crisis years were so bad that even several strong years of investment returns have not been enough for MSERS to achieve its expected rate of return on average. And even though Michigan has made &ldquo;larger payments&rdquo; in recent years, those payments still haven&rsquo;t been at or above 100% of the actuarially determined rate.</p>
<p>That said, even if required contributions to APERS and ATRS had <em>not</em> increased in dollar terms (assuming everything went well for the plans), the contribution <em>rates</em> would necessarily increase because of the simple arithmetic of the measurement point. With payroll declining, reporting contributions as a percentage of payroll is no longer a meaningful benchmark for how expensive a plan is. With a $1 billion payroll, contributions of $100 million are 10% of payroll, and with a $10 million payroll, contributions of $5 million are 50% of payroll&mdash;the latter is clearly less, even though the rate in percentage terms is higher. It is important to always distinguish between the expenses of a plan and the actual, long-term costs.</p>
<p>&nbsp;</p>
<p><strong>Conclusion</strong></p>
<p>In the fall of 2014, the city of Phoenix was considering a ballot measure that would have introduced a defined contribution plan for new members. During a hearing at city hall a number of public sector union members stood up in opposition to the pension reform effort, citing the growth of unfunded liabilities in Michigan and Alaska as evidence that changing from defined benefit to defined contribution is bad for a municipal pension fund.</p>
<p>In the spring of 2015, the state of Nevada was considering a legislative effort to introduce defined contribution benefits for state employees. During a state assembly hearing, a number of public sector union members stood up in opposition to the pension reform effort, also citing Michigan&rsquo;s and Alaska&rsquo;s unfunded liability growth in the years following their pension reforms as a reason to reject the proposed reform.</p>
<p>In both cases, the local press repeated the claims in stories about the pension reform efforts, spreading the misinformed analysis about Michigan and Alaska. In both cases, the pension reform efforts failed&mdash;with Phoenix residents voting down their measure, and Nevada legislators killing their effort before it even got out of committee.</p>
<p>The individuals presenting these arguments about Michigan&rsquo;s and Alaska&rsquo;s pension reform efforts are sometimes innocent of the analytic failures behind them, such as when they are union members sent forward by their leadership, armed with talking points and tasked with presenting them. Other times those advancing the misleading arguments are in a position to know better, such as educated economists or actuaries with a personal or ideological stake in stopping the proposed reform.</p>
<p>A defined contribution plan might offer even more generous benefits than a defined benefit plan, and thus have a higher normal cost that increases employer contribution rates&mdash;but in such a case, the higher <em>costs</em> would be an explicit and intentional policy decision by elected officials, since the costs of a defined contribution plan are only the defined contribution rate. By contrast, unfunded liability pension costs are not due to elected officials choosing to budget for them, but instead are costs related to previous funding policy failures by elected officials.</p>
<p>In light of this, journalists covering pension reform stories should not repeat the myths about changing from defined benefit to defined contribution plans. There may well be good reasons to vote down a pension reform proposal&mdash;neither the Phoenix nor the Nevada measures were perfectly designed reforms. However, when informing the public about the merits or detractions of any particular reform that closes a defined benefit plan, the press should not repeat the myths that such a closure and replacement with defined contribution benefits <em>will cause</em> or <em>has caused</em> increases in unfunded liabilities.</p>
<p>&nbsp;</p>
<p><em>-- Footnotes --</em></p>
<p><a href="#_ednref1" name="_edn1">[1]</a> In both states, employers underfunded the plan by skipping out on required contributions, while at the same time the allocation of pension plan assets resulted in investment returns that significantly underperformed the long-run assumed rate of return. The actual savings have been much lower, but only relative to the funding policy failures of each state that are unrelated to pension reform. If Michigan and Alaska had managed the pension reform process correctly, they would have experienced the $7 billion and $4 billion in savings, respectively. The fact that their pension plans still have significant unfunded liabilities is due to mismanagement of the closed defined benefit plans, the costs of which have consumed the majority of the savings that pension reform created.</p>
<p><a href="#_ednref1" name="_edn1">[2]</a> Teresa Ghilarducci (2015), &ldquo;<a href="http://bit.ly/1EVJaZi">Nevada PERS a model for nation; don&rsquo;t change it</a>,&rdquo; <em>Review Journal</em>, March 16, 2015.</p>
<p><a href="#_ednref2" name="_edn2">[3]</a> Total required contributions to MSERS defined benefit plan between 1997 and 2014 have been roughly $5.5 billion, using the plan&rsquo;s 8% discount rate to value accrued liabilities and determine contribution rates. Using a 7% discount rate, the contribution requirements would have been closer to $7.6 billion over the same time frame. For more on our policy findings about the most appropriate way to determine a discount rate, see: Anthony Randazzo and Truong Bui (2015), &ldquo;<a href="http://reason.org/files/pension_discount_rates_best_practices.pdf">Why Discount Rates Should Reflect Liabilities: Best Practices for Setting Public Sector Pension Fund Discount Rates</a>,&rdquo; <em>Reason Foundation Policy Brief 130</em>.</p>
<p><a href="#_ednref3" name="_edn3">[4]</a> Michael Hiltzik (2015), &ldquo;<a href="http://lat.ms/1JfMLiR">Public pension shocker: Shutting a pension plan actually costs taxpayers money</a>,&rdquo; <em>Los Angeles Times</em>, August 21, 2015.</p>
<p><a href="#_ednref4" name="_edn4">[5]</a> National Institute on Retirement Security (2015), &ldquo;<a href="http://bit.ly/1cy9HQl">Case Studies of State Pension Plans that Switched to Defined Contribution Plans</a>,&rdquo; February 2015, p. 10.</p>
<p><a href="#_ednref5" name="_edn5">[6]</a> Another way this particular myth is expressed is by arguing that because closing a plan cuts off new members, it cuts off contributions from those members. Ghilarducci claimed as much when she argued that Michigan&rsquo;s growth in unfunded liabilities was because &ldquo;new employees were not contributing to the old plan, and had to contribute to the new plan, [while] the system still had to pay benefits to the old members while assets were falling.&rdquo; In one respect this can&rsquo;t possibly be true, because employees in MSERS weren&rsquo;t required to make contributions to the plan until 2011. Prior to reform MSERS was a &ldquo;non-contributory&rdquo; plan for employees, and after reform only members of the defined contribution plan had to make employee contributions. But even if there were required employee contributions, they would not be necessary from new members to help pay down the debts of previous members. Employee contributions are only supposed to be relative to their own benefits (see pages 6-7&nbsp;of our recent policy study, &ldquo;<a href="http://reason.org/files/ps450_pension_reform_sustainability_effects.pdf">Did Pension Reform Improve the Sustainability of Pension Plans?</a>&rdquo;).</p>
<p><a href="#_ednref6" name="_edn6">[7]</a>Teresa Ghilarducci (2015), &ldquo;<a href="http://bit.ly/1VuthhW">Nevada Pension Reform: First, Do No Harm</a>,&rdquo; <em>Oral testimony to the Nevada State Legislature</em>.</p>
<p><a href="#_ednref7" name="_edn7">[8]</a> Changes to actuarial assumptions (in particular, the discount rate) have moved the state toward a higher&mdash;though more accurate&mdash;recognition of the value of accrued liabilities, and thus are reporting larger unfunded liabilities today simply by virtue of a change in the discount rate relative to the pre-reform years. Thus, at a very simple level it is inaccurate to suggest that the increased contribution rates in Alaska are because of the closed defined benefit portion of the plan.</p>
<p><a href="#_ednref8" name="_edn8">[9]</a>&nbsp;<a href="http://bit.ly/1cy9HQl">National Institute on Retirement Security</a> (2015), p. 5.</p>1014486@http://www.reason.orgTue, 29 Mar 2016 09:00:00 EDTanthony.randazzo@reason.org (Anthony Randazzo)Did Pension Reform Improve the Sustainability of Pension Plans?http://www.reason.org/news/show/counterfactual-pension-reform-analy
<p>Can closing a defined benefit pension plan to new hires and replacing it with a defined contribution plan help improve the solvency and sustainability of a state&rsquo;s retirement system finances?</p>
<p>In 1996 the Michigan legislature voted to close its defined benefit plan for state employees, offering defined contribution retirement benefits for new hires. In the years since then the closed defined benefit plan has added over $5 billion unfunded liabilities. Some say that this evidence proves the answer to our question is, &lsquo;no, inherently closing defined benefit plans creates unfunded liabilities.&rsquo; Yet, such a position is only highlighting the <em>correlation</em> between a closed pension plan and a growth in pension debt.</p>
<p>In order to understand whether closing the Michigan State Employees Retirement System (MSERS) defined benefit pension plan <em>caused </em>a growth in unfunded liabilities, or whether it helped to improve the sustainability of retirement benefits in the Wolverine State, we developed a model that allows us to test what would have happened if pension reform never passed.</p>
<p>Our model allows us to forecast the level of unfunded liabilities today if there had been no reform, and to test what unfunded liabilities would be if Michigan had managed the closure of the defined benefit plan differently. We also apply our model to the case of Alaska&rsquo;s 2005 pension reform that closed both their Public Employees&rsquo; Retirement System (APERS) and Teachers Retirement System (ATRS) to see if there are similar results.&nbsp;In both cases, where unfunded liabilities have grown in the years following pension reform, we seek to understand:</p>
<ul>
<li>whether the closing of defined benefit plans was the <em>cause</em> of growth in unfunded liabilities,</li>
<li>whether unfunded liabilities were bound to grow anyway because of actuarial assumptions,</li>
<li>whether unfunded liabilities increased due to funding policies that were independent of closing a defined benefit plan, and/or</li>
<li>whether closing the defined benefit plan prevented unfunded liabilities from growing more than they would have in the absence of reform.</li>
</ul>
<p><em><strong><a href="http://reason.org/files/ps450_pension_reform_sustainability_effects.pdf">Download the full Policy Study 450 [PDF]</a></strong>, and see below for more resources on pension finance research.</em>&nbsp;</p>
<p><strong>The Counterfactual Model<br /></strong></p>
<p>The baseline for our counterfactual model is the actual experience of the defined benefit plan, measuring from the fiscal year before the plan was closed through fiscal year end 2014. For Michigan the time horizon is 1996-2014, for Alaska it is 2005-2014. We started with publicly available data drawn from plan valuations and comprehensive annual financial reports, including: payroll, employer contributions, employee contributions, investment returns, and benefit outflows.</p>
<p>The model assumes that states would have maintained a similar contribution policy with or without reform, since whether a defined benefit plan is closed or taking in new hires, the full actuarially determined employer contributions should still be paid in full. There is nothing about a plan being closed that should change whether or not employers pay their required contributions.</p>
<p>Since both Michigan and Alaska had patterns of underfunding, the actual employer contribution rate relative to the actuarially determined rate is a significant variable in testing alternative scenarios.</p>
<p>Similarly, another key variable for testing changes to unfunded liability forecasts is the actual rate of return for a plan&rsquo;s assets. With or without reform, a plan would have seen the same rates of return over time.<a href="#_ftn1" name="_ftnref1">[1]</a> Thus, our model assumes there would be no difference in the investment strategy of a plan if it had remained open to new members versus the actual experience of being closed.<a href="#_ftn2" name="_ftnref2">[2]</a> Thus, for forecasts of a counterfactual scenario where reform didn&rsquo;t happen, we apply the same rates of return as during actual experience. But we can also measure the change in unfunded liabilities if the pension plan had achieved its assumed rate of return.</p>
<p>Since the pension reforms adopted did not make substantive changes to benefits, the model assumes normal costs would have been the same in the absence of the reform; however, amortization payments would have been different. The most straightforward way to determine contributions to plan assets under a no-reform counterfactual scenario is to take the actual contributions and then add to them additional normal cost contributions, which is the primary approach we take for calculating the numbers we report in this study. (See the methodology section in the policy study for more details.)</p>
<p>Finally, we can reasonably assume that benefit outflows would have been similar to the actual experience if reform had not happened. Most changes to the plans we looked at were only for new hires, not existing members. Thus, retirement patterns have not been substantially influenced. For the new hires, there has not been enough time for their cohorts to start retiring in large amounts as no scenario we test involves 20 years or more of actual experience.<a href="#_ftn3" name="_ftnref3">[3]</a></p>
<p><strong>Scenario 1: What if Pension Reform Had Not Happened?</strong></p>
<p>There is no doubt that MSERS has more reported unfunded liabilities today than it did in the year before pension reform was adopted (even accounting for inflation). But did pension reform <em>cause </em>the increase in pension debt?</p>
<p>Between 1997 and 2014, employers paid less than 88% of their annual required employer contributions to the MSERS defined benefit tier. In some years the total employer contribution was less than 50% of the actuarially determined rate that should have been paid. The lower-than-required contributions made budgeting easier for lawmakers, but at the long-term expense of the plan, with the missed payments simply being added to unfunded liabilities.</p>
<p>In the years since the defined benefit plan was closed, MSERS has also underperformed its long-standing 8% assumed rate of return. Between 1997 and 2014, MSERS has averaged a return of only 7.1% (see nearby Figure 2 from the policy study). Similarly, the actuarially valued returns (smoothed on a five-year basis by the plan actuary) have almost always been below the assumed rate of return since 2001. The net result of these poor investment returns over the past two decades has been to add to the unfunded liabilities of the defined benefit plan.</p>
<p style="text-align: center;"><img src="/files/pensions/Figure 2, Investment Returns MSERS.png" alt="MSERS Investment Returns" width="1410" height="960" /></p>
<p>Other factors have been direct causes of growth in unfunded liabilities too, including the use of a very long amortization schedule for unfunded liabilities that has meant higher than necessary interest payments on the pension debt, a retroactive increase in benefits for employees who were willing to retire early, and the misuse of pension funds to provide a public backstop for a bond issuance to a private film studio that wound up defaulting on the loan.</p>
<p>Now, consider a counterfactual scenario in which the vote to close MSERS failed in the state legislature and no reform was adopted. The plan would have continued bringing in new members, but it still would have experienced the same underperforming investment returns. The additional unfunded liabilities would have resulted in actuarially determined employer contribution rates <em>higher </em>than actual experience, so we can assume that the state would have likely also become a serial under-contributor even without the passage of reform.<a href="#_ftn1" name="_ftnref1">[4]</a></p>
<p>Table 1 provides a financial comparison of this counterfactual scenario to MSERS&rsquo;s actual experience. (See the Methodology section in the policy study for details on our forecasting method for counterfactual scenarios.)</p>
<p><img src="/files/pensions/Counterfactual_Table1.png" alt="Table 1, Counterfactual Paper" width="900" height="456" /></p>
<p>There are several important findings from this table. First, while we estimate the value of assets would be higher today without pension reform, so too would accrued liabilities. So much so that unfunded liabilities would be roughly $440 million larger today. At a minimum, the actual experience of the plan would be preferred to no reform because today&rsquo;s unfunded liability is lower than it otherwise would have been.</p>
<p>Second, notice that the funded ratio for MSERS as a whole is better today (88%) under actual experience than it would have been without pension reform (70%). As of 2014, roughly two-thirds of MSERS payroll was in the DC tier, and member benefits for that tier are inherently 100% funded.</p>
<p><strong>Scenario 2: What if Pension Reform Had Been More Responsibly Managed?</strong></p>
<p>Michigan certainly could have done a better job&#8232;determining its funding policy and plan governance&#8232;over the last two decades during the plan closure. To&#8232;start, the state could have made 100% of its&#8232;actuarially determined employer contributions.<a href="#_ftn1" name="_ftnref1">[5]</a>&nbsp;Plus, if the plan had achieved the assumed rate of return that was assumed when pension reform was adopted, unfunded liabilities would be much less.<a href="#_ftn2" name="_ftnref2">[6]</a>&nbsp;This provides another benchmark to compare to actual experience: a counterfactual scenario where pension reform was better managed.</p>
<p>Table 2 compares MSERS&rsquo;s plan financials of this second counterfactual scenario to the first counterfactual scenario of &ldquo;no-reform&rdquo; and to the plan&rsquo;s actual experience. Specifically, we consider what the pension financials would look like if the plan&rsquo;s actual investment returns matched the assumed rates of return, and if Michigan had a responsible funding policy of paying the full bill every year.</p>
<p><img src="/files/pensions/Counterfactual_Table2.png" alt="Table 2, Counterfactual Paper" width="900" height="477" /></p>
<p>Better pension reform management&mdash;from the perspective of paying the full employer contribution rate every year&mdash;and targeting an achievable rate of return would have only affected the plan&rsquo;s assets. We forecast that these two elements alone would have added roughly $7 billion to MSERS&rsquo;s assets today. And since the accrued liabilities would not have been changed, this would have meant a $2.1 billion surplus for MSERS by the end of 2014.<a href="#_ftn1" name="_ftnref1">[7]</a></p>
<p>Given that the central research question for this study is focused on whether closing a defined benefit plan to new hires <em>caused </em>the increase in unfunded liabilities, this scenario helps to provide a baseline for what would have been the assumed future for MSERS when the reform was adopted. In this case we find that if all of the defined benefit plan&rsquo;s assumptions at the time of pension reform had been accurate, then the plan would be in a better fiscal position today than both actual experience and if there was no reform.</p>
<p>The most sustainable scenario is adopting the pension reform of closing the defined benefit tier of MSERS and opening a defined contribution tier for new members, <em>plus </em>prudent funding policy and investment strategy.&nbsp;</p>
<p><strong>Conclusion</strong></p>
<p>We find that both Michigan and Alaska are better off specifically because they closed defined benefit plans compared to if they had made no changes. Unfunded liabilities have increased in both states since their reforms, but for reasons unrelated to the actual reforms: both states had underperforming investment returns, and both states failed to make 100% of their required employer contributions. Had Michigan and Alaska not closed their pension plans, unfunded liabilities would be even higher today than under actual experience. And had the states properly managed their pension reform projects they would be billions better off today. In effect, the states have &lsquo;spent&rsquo; the savings from closing the defined benefit plans on other budgetary priorities.</p>
<p>By developing a forecast of what plan experience would have been like without closing to new members, we find Michigan is about $450 million better off today <em>because </em>of pension reform. As of the end of 2014, MSERS has an unfunded liability of $5.2 billion and combined funded ratio of 88%; by contrast, without pension reform closing the defined benefit tier, we estimate the plan&rsquo;s unfunded liability would be $5.6 billion with a funded ratio of 70%. Assuming the plan would have experienced the same contribution rates, actuarial assumption changes, and investment returns, this means pension reform has saved Michigan around $450 million over 18 years. Plus, if the state had achieved its assumed rate of return and paid 100% of its annual required contributions, we estimate MSERS would actually be overfunded by about $2.1 billion, as of 2014&mdash;a $7.7 billion better financial position than without pension reform.</p>
<p>Similarly, Alaska is at least $40 million better off than if it had not closed its two main plans to new members. As of the end of 2014, APERS and ATRS have a combined $8.37 billion unfunded liability, and funded ratio around 71%. However, without reform the plans would be facing $8.41 billion in unfunded liabilities and a 58% funded ratio. Assuming the plan would have experienced the same contribution rates, actuarial assumption changes, and investment returns, this means pension reform has saved Alaska at least $40 million over 10 years. Plus, if the state had achieved its assumed rate of return and paid 100% of its annual required contributions, we estimate APERS and ATRS&rsquo;s combined unfunded liability would be just $4.1 billion, meaning the plan would have been $4.3 billion better off if properly managed during reform compared to having no reform.</p>
<p>These findings are in contrast <a href="http://bit.ly/1cy9HQl&nbsp;">to a 2015 study</a>&nbsp;from the National Institute on Retirement Security (NIRS), which argued, &ldquo;changing from DB to DC does not decrease retirement plan costs, can drive up pension debt, and will almost certainly increase retirement insecurity.&rdquo;The study specifically highlighted Michigan&rsquo;s pension reform as evidence for how closing pension plans increases unfunded liabilities: &ldquo;while the plan had excess assets on hand of some $734 million in 1997, by 2012, the plan amassed a significant unfunded liability of $6.2 billion.&rdquo;</p>
<p>However, as we&rsquo;ve shown, such a finding is conflating correlation with causation and inaccurately blaming the pension reform itself for the increase in pension debt. By constructing counterfactual scenarios, we&rsquo;ve shown that the additional unfunded liabilities are due to factors unrelated to the closing of a defined benefit plan: the state&rsquo;s failure to pay its full employer contribution and underperforming investment returns (which would have happened with or without the reform).</p>
<p>Policymakers considering similar reforms to Michigan and Alaska should understand that closing a defined benefit plan and replacing it with a defined contribution plan <em>can improve sustainability</em>. They should also heed the warnings that Michigan and Alaska present in recognizing that responsibly managing plans after reform is just as important as getting the initial terms of the reform right.</p>
<p><em>-- Footnotes --</em></p>
<p><a href="#_ftnref1" name="_ftn1">[1]</a> This assumes that investment strategy that plans followed in the years after defined benefit plans were closed would have been the same without reform, and that without reform there wouldn&rsquo;t have been any separate changes to investment policy. Given that there is no legal or fiscal reason to change the distribution of assets in a plan&rsquo;s portfolio simply because a plan is closed, we consider this a reasonable assumption.</p>
<p><a href="#_ftnref2" name="_ftn2">[2]</a> The only investment return difference is that losses or gains would have been a magnitude greater if the plans had remained open, because there would have been more contributions flowing into the plan assets.</p>
<p><a href="#_ftnref3" name="_ftn3">[3]</a> See &ldquo;Methodology&rdquo; section for more details on how we forecast benefits. The biggest possible exception to our assumption is that Michigan offered an early retirement option to members who remained in their defined benefit plan as a means of turning over the payroll to defined contribution members faster.&nbsp;</p>
<p><a href="#_ftnref1" name="_ftn1">[4]</a> There are some obvious limitations to this forecast: we have to assume normal cost as a percent of payroll would remain the same (the actual rate would have likely varied slightly), and we have to assume the defined contribution tier&rsquo;s payroll would have been the same if new hires went into the DB tier instead of the DC tier.&nbsp;</p>
<p><a href="#_ftnref1" name="_ftn1">[5]</a> This would have necessitated cuts in other programs or an increase in taxes, which are considerable policy considerations for a government as a whole. However, to the degree that under-contributing to a plan increases pension debt, the additional payments that will need to be made on that debt in the future are never attributed as costs of the programs (though, arguably, they should be). It is worthwhile to consider what fiscal policies are necessary to fund a pension plan on its own terms, separate from other policy considerations.</p>
<p><a href="#_ftnref2" name="_ftn2">[6]</a> We mean &ldquo;better management&rdquo; in the context of the assumed rate of return in two respects. First, the plan could have hired a different asset manager or better redistributed its assets so as to actually get the average return. This is, naturally, a critique that is only possible in retrospect, after seeing how average returns play out over a number of years. Presumably, the MSERS board did everything it could to manage the plan&rsquo;s assets well. However, this leads us to the second way we mean &ldquo;better manage&rdquo;&mdash;the board should have lowered the assumed return to something manageable. This would have necessitated higher required contributions, but if they had been paid in full and the more achievable rate successfully attained, then the plan would be more solvent today. There are certainly policy trade-offs that come with increasing the contribution rates for a plan, but that does not negate the simple reality that if the plan had either done a better job of managing its assets, or better positioned itself for success (i.e. targeted a lower assumed return rate), it would be better off today.&nbsp;</p>
<p><a href="#_ftnref1" name="_ftn1">[7]</a> It is probable that well before a $2 billion surplus was reached, that funding policy would have changed to reduce contributions into the plan. However, a large surplus would have been beneficial to build because it would serve as a cushion against future potential underperforming markets.&nbsp;&nbsp;</p>1014480@http://www.reason.orgTue, 29 Mar 2016 09:00:00 EDTanthony.randazzo@reason.org (Anthony Randazzo)